When the White House Office of Management and Budget indicated last week that President Trump will be seeking deep cuts in non-defense discretionary spending while asking for a $75 billion increase in defense spending to a record $750 billion in the upcoming fiscal year 2020 budget, House Democrats barely flinched.
Even the OMB’s brazen but dead-on-arrival proposal to slush-fund a quarter of the defense spending into the Pentagon’s off the books “Overseas Contingency Account” drew little more than a shrug.
Instead, Democrats mostly saw the defense spending boost as an opening bid.
*** We believe, as we first highlighted last year (SGH 9/10/18, “US: Midterms, Trade, and a Fiscal Accelerator”), the new fiscal year beginning this October 1 is highly likely to see an increase in federal defense and non-defense discretionary spending equal to or exceeding the 16% rise in federal outlays under the Bipartisan Budget Act of 2018. In other words, in contrast to the Federal Reserve’s base case projections for a “fiscal fade” this year and next, there is likely to instead be another round of fiscal stimulus that will almost certainly extend through the November 2020 elections. ***
*** The Democratic-controlled House will be driving the budget process, and they see the 2018 BBA as a “template” to the budget negotiations over the next seven months, namely, a dollar for dollar matching of increases in defense and non-defense discretionary spending — why they took the large increases in defense spending in stride. And while OMB, conservative Republicans, or “Blue Dog” Democrats may offer dismay over the spiraling federal deficit, there is little to no real political resistance in either the White House or on Capitol Hill in either party to higher federal outlays. ***
*** The budget negotiations get underway next week when the OMB presents its outline of President Trump’s budget priorities on March 11. The President’s cuts to non-defense spending will essentially be ignored on Capitol Hill, and the first signs of the scale to the more likely increases in total discretionary spending should become apparent in the House Budget Resolution sometime in May. An even larger Omnibus package then seems likely in September, when we suspect a “must pass” bill to increase the federal debt ceiling no later than September may be used to ensure passage of the new fiscal “accelerator.” ***
The New Political Dynamics
The current discretionary spending levels through September 30 this year were set by the Bipartisan Budget Act of 2018. It increased defense and non-defense spending by nearly $300 billion, or about 16% (defense by 17%, non-defense by 15%) to $1.244 trillion from $1.070 trillion in 2017, an increase equal to about 0.7% of GDP.
The prior budget levels were set under the Budget Control Act of 2011 which had established spending caps going forward, but which were then set to be drastically reduced by some $90 billion a year after the failure of the Joint Select Committee on Deficit Reduction in the fall of 2012.
Congress passed two previous budgets in 2013 and 2015 to override the sequester, but the 2011 BCA is in fact still in effect until fiscal year 2021. That means a failure to pass a new budget before October 1 this year would translate into real spending cuts from current levels by around 10% or $125 billion going into the 2020 elections, an unlikely turn in fiscal policy.
Indeed, while too much has been made of the so-called “Modern Monetary Theory” of a free pass on federal spending, the intellectual and ideological climate on Capitol Hill has clearly shifted to a greater willingness to consider higher spending levels and larger deficits; the Budget Committees, for instance, are unlikely to even bother trying to balance the federal budget over the CBO’s ten-year baseline.
What’s more, the ranks of the “deficit hawks” in both parties in Congress have been thinned by retirements or in no longer carrying much political weight. The GOP House Freedom Caucus, for instance, has essentially lost all its legislative muscle now that the GOP lost its majority.
In addition, it is important to stress that the boost to federal spending we see doesn’t have anything to do with the large scale trillion dollar-plus infrastructure spending plans talked about by President Trump or progressive Democrats, or for that matter, the high ticket costs of Democratic proposals for a “Green New Deal” or “Medicare For All” — tapping into the Fed’s balance sheet to boot.
Instead, this is just plain old pork barrel spending increases that should boost demand in the aggregate — which is what the Fed will have its eye on — while helping out selective economic and voting blocs well represented in the Democratic Party and the GOP-favored defense industry states and congressional districts.
Higher entitlement spending — already baked in the cake via the expanded eligibility for Medicaid support that is now state-driven but conveniently mostly funded by the federal government — and the more expansive infrastructure spending like the New York-New Jersey “Gateway” project, would in fact come in later, additional, parallel legislation.
House Budget Resolution Instructions
The Democratic House leadership is already debating how they can use the budget resolution to support a desired increase in non-defense discretionary spending. One tactic under consideration is to include language in the budget resolution to instruct the House Ways and Means Committee to seek additional revenues, either from a financial transaction tax, or through net increases in top marginal income tax rates.
While there is little chance either revenue raiser will actually pass, certainly not as currently envisioned, the appropriation subcommittees would then be instructed to work off spending totals that could be significantly higher than the levels in the previous fiscal year on the non-defense programs.
It is the Democrats’ version, in some sense, of the Trump administration claims of the 2018 tax cuts paying for themselves, or of Mexico paying for “the Wall.” And it could also help to bridge any differences between those moderate Democrats still reluctant to deepen the deficit and Progressives pushing for a large-scale shopping list of spending in order to get the 218 votes needed to pass the resolution in the eventual floor vote.
The Senate Republicans, on the other hand, with a larger but a more skittish majority than last Congress, may struggle even more to assemble a budget resolution that can garner 51 of their 54 votes. Most Senate Republicans support increasing defense spending as a national security necessity. But even if they deploy the highest economic growth assumptions, they will not be able to vault over all of the gaps in a single resolution.
It follows that most Senate Republicans will accept the OMB budget gimmick of shoveling a quarter of the Pentagon budget off-the-books and into the Overseas Contingency Fund. The only other choices are to follow through on the deep cuts to non-defense spending to make room for the defense spending increases along the lines of the OMB’s expected budget outline next week. But that is very likely to sink a budget resolution altogether by losing a handful of Senate Republican moderates facing re-election in purple or blue states in 2020. Otherwise, the Senate Republican leadership will need to cede the political ground on a higher deficit or vote to include increases in taxes. Both are highly unlikely to say the least.
We suspect the Senate Republican leaders will walk away, as quietly as possible, rather than open a schism within their own ranks while also risking a public scuffle with the White House, with the two most likely outcomes for a budget resolution in the Senate either a meaningless budget resolution designed to get the bare minimum 51 votes, or none at all.
And that may underscore a likely procedural upper hand favoring the House: even if either or both of the possible House revenue raising bills are near certain to be rejected in the Senate, it still provides the House Democrats with both bigger spending numbers and a resolution to back them up as they enter into the negotiations this fall: that is when parallel Senate and House spending bills need to be merged into what is likely to be a giant Omnibus package in September.
In other words, the Democrats are already getting ready for an end of the fiscal year battle with the Senate Republicans and President Trump. We believe this will result in both parties defaulting to higher levels of spending on both non-defense, and defense, spending programs.
Overlapping “Shared Destinations”
Market skepticism for another fiscal stimulus comes in two forms, largely on the predictions of political dysfunction and gridlock. The first is why President Trump would go along with Democratic budget proposals when the House is at the same time burying the White House with subpoenas and investigations building towards an impeachment case? The second is why Democrats would not seek to avoid a fiscal stimulus that, in boosting the economy, might help the President’s re-election prospects?
We think, however, that both arguments profoundly misunderstand the current political dynamics in the White House and on Capitol Hill. Republicans fear any substantial deficit talk could build into a first step to rolling back their tax cuts, while Democrats see deficit concerns as the opening gambit to cutting entitlements or their favored programs in education and health. And President Trump has to date not been shy about spending to stimulate the economy.
While the President’s budget outline next week, for instance, is likely to propose deep cuts in non-defense discretionary spending and to highlight the dangers of the spiraling fiscal deficit, President Trump offered the same sort of initial language in the previous two budgets, while eventually signing off on the spending surges under the BBA negotiated by then House Speaker Paul Ryan and Senate Majority Leader Mitch McConnell.
And Trump, more than anyone else, appreciates a strong economy with low interest rates, low oil prices, and trade victories will be essential to lifting his support from his core base towards the 50% mark to be re-elected in 2020. Fiscal retrenchment is hardly the path to such a positive economic backdrop to the campaign.
Meanwhile the Democrats, having wrestled back control of the House, are not about to abandon their window of power to somehow “time” federal fiscal programs around the November 2020 elections.
Over the last two decades the party has watched the GOP drive the budget aggressively into deficit, twice, to realize their tax cut and defense spending ambitions. This time round, with pent-up spending demands to meet the priorities of their own constituencies, Democrats are determined to push through their programs just as aggressively while they have the political window and means to do so, be that pre-K and other educational and technical training programs, a higher minimum wage, expanded health benefits, and financial support to “fixes” to Obamacare.
In other words, our expectations are not predicated on a notion that Democrats will be “meeting in the middle” with the White House and Senate Republicans over a “deal” with hard fought compromises as traditionally understood, but rather that each side will see their fiscal policy ambitions overlap in a “shared destination” that will translate into another boost to federal discretionary spending. The preparations are already underway.
Gridlock, it should be noted, is almost always resolved through higher spending.