The four-way tug-of-war that explains Republicans' tax challenge

• The key decision-makers in the White House and on Capitol Hill are like a person in the center of a four-way tug-of-war, in which giving a little in any one direction causes problems with the other three.
• As work begins on Republicans' biggest legislative priority, understanding this web of interconnections and trade-offs is crucial to making sense of daily developments.

Zoom out: One of this unlucky person's arms is pulled by forces demanding the biggest tax cuts possible. But there are two directions that can go.

• One way is toward business-centric pro-growthers who seek tax changes to incentivize corporate investment.
• More populist candy-throwers pull in another direction. They want to offer tax benefits that may poll well but don't grow the economy's potential.

Then there's the other arm, tugged in the direction of fiscal restraint — from the bond vigilantes in one direction and spending hawks in the other.

State of play: A 50-page document that congressional Republicans have circulated in recent weeks offers a menu of hundreds of provisions that could plausibly be included in a final bill.

• Each provision comes with an estimate of how much it would either increase or decrease the deficit — which can be broadly categorized as pulling the final bill in one of those four directions.
• The months ahead will be a process in which the tax-writing committees in the House and Senate try to sort through the political trade-offs to arrive at a bill that can pass with near-unanimous Republican support.

What they're saying: "A lot of these policies have been known about as options all along," Joseph Boddicker, counsel at Alston & Bird and a former Senate Republican tax aide, tells Axios.

• "That piece isn't as difficult. I think they have the various puzzle pieces. They just need to know, ultimately, what it is that they're trying to build."

The pro-growth imperative

The bedrock of Republican economic philosophy since at least President Reagan has been the potential for a well-designed tax policy to unleash much faster economic growth.

• But not all tax cuts are created equal.
• Tax provisions that give companies greater incentive to invest — to build factories, spend on research and development, and so forth — result in higher capital stock and higher economy-wide productivity.
• That should mean higher incomes.

Between the lines: Business interests and more traditional conservatives like former Vice President Mike Pence want to make sure these concerns don't get lost in the shuffle, amid Trump's emphasis on tariffs and tax breaks that resonated on the campaign trail.

• "When you talk to any business out there in the country, they come quickly to R&D expenses, to capital expensing, to interest deductibility — because they're living it every day and they know exactly what it means to their bottom line," U.S. Chamber of Commerce CEO Suzanne P. Clark told Axios earlier this month.

Zoom in: The original 2017 Tax Cuts and Jobs Act reduced the corporate income tax rate from 35% to 21%. Trump has spoken of lowering it further.

• Lowering it by 1 percentage point to 20% would reduce revenue over the next decade by $73 billion, per the Republican menu of options. Going all the way down to 15% would mean a whopping $522 billion.
• That's money that either would increase the deficit or reduce the amount of money for tax cuts that put money more directly in Americans' pockets.

In effect, the policies that conservatives believe would strengthen the economy most are also some of the easiest for Democrats to attack as giveaways to big corporations.

The populist tug

Another conservative mantra is that optimal tax policy should "lower the rate, broaden the base," meaning tax various forms of income equally, but at as low a rate as possible. Trump has blown up that notion.

On the campaign trail, he spoke of a slew of policies that don't fit that conservative philosophical tradition.

• He advocated exempting tip income and overtime pay from taxation, making interest on auto loans deductible, and ending a cap on the deductibility of state and local taxes.
• Those provisions would shift the tax burden around, away from specific classes of people (like waiters, people who put in a lot of overtime, car buyers who don't pay cash, and residents of high-tax states).

By the numbers: Whatever you think of those as policy choices, the revenue reductions they imply would either increase the deficit or leave less room for the supply-side tax cuts preferred by businesses and traditional conservatives.

• The tip income elimination comes to $106 billion over a decade, overtime $750 billion, and auto loan deductibility $61 billion.
• Eliminating the cap on deductibility of state and local taxes (SALT) entirely would cost a massive $1 trillion. (The menu document also shows compromise options to raise the cap, but not eliminate it, that are less costly.)

Of note: The SALT debate could prove one of the most divisive within the Republican caucus. It presents a zero-sum tension between the low-tax states and high-tax states — and neither side's Republican lawmakers want to give an inch.

Different deficit economics

The macroeconomic backdrop to this tax bill is completely different from the one eight years ago.

• That could curtail Republican lawmakers' ability to paper over those tensions between their coalition's business and populist wings by simply letting everybody get what they want and running up the budget deficit.

Flashback: In 2017, interest rates were in the low 2% range. Now they're around 4.5%.

• Inflation then was below the Fed's 2% target. Now it has been above that target for four straight years.
• Back then, the national debt was a mere 75% of GDP; now it's 100%. The Congressional Budget Office in January 2017 projected deficits of 2% to 4% of GDP; now that trajectory is 6% to 7%.

In effect, the United States is in a more vulnerable fiscal position now than it was eight years ago. Already, longer-term interest rates — which are set in global bond markets — have risen since the election, in part due to investors' worries about larger deficits.

• Treasury Secretary Scott Bessent has said he wants to bring the deficit down to 3% of GDP, which would require hundreds of billions in deficit reduction.

What to watch: If the push to tax reform looks like it's going in a direction that will make the fiscal outlook meaningfully worse, Treasury bonds could sell off, which would get the attention of the White House and congressional leadership.

The spending cut path

In order to achieve major tax cuts without blowing out the deficit, the bill could include major spending cuts.

• That could help create the fiscal space to offer both business and populist interests their desired tax cuts, but it wouldn't necessarily make the overall politics any easier.

The Republicans' menu of policy options includes numerous spending reductions, many of which involve reducing spending on Medicaid, the program that funds health care for millions of lower-income Americans.

• Other leading cash-saving options include repealing or reducing clean energy subsidies that were included in the Biden administration's signature Inflation Reduction Act.

Reality check: There's a reason the TCJA was not paired with spending cuts. Every dime of spending that is slashed eliminates someone's revenue — and they will fight to keep it.

• Medicaid is popular and supports health care systems in red and blue states alike. Hospitals and other medical industries would fight cuts.
• The Biden clean energy investments have disproportionately flowed to red states as well, and some Republican lawmakers would be loath to risk damage to big local employers.

Medicaid cuts especially would create a cudgel for Democratic attacks on the bill — that Republicans are giving wealthy people and companies tax cuts to cut working-class peoples' health care.

• "I just can't imagine achieving spending reductions of the magnitude that's being suggested without there being considerable dissent," said Boddicker.

The bottom line

Republican leadership is well aware of these trade-offs and determined to resolve them.

• Many of the Trump tax cuts will expire at the end of the year if new legislation is not passed, which is a powerful forcing mechanism.
• But given the complexity and difficulty of the political and economic trade-offs, expect lots of ups and downs, near misses, and jockeying for position in the meantime.

We know that the tug-of-war has begun, but we don't yet know how it will end.