US Fiscal: Road Map

Published on October 24, 2013

The first meeting of the 29 member House-Senate Budget Conference Committee is set, appropriately enough, for October 30, the same day the Federal Open Market Committee issues its October meeting statement.

Low expectations surround the likely outcome by the BCC’s December 13 deadline to make its recommendations on the FY2014 budget. Without a budget agreement, the prospects for even the smallest of “baby grand bargains” — replacing the fiscal head-winds of the sequester with minor but fundamental eligibility adjustments to entitlement spending — will flicker out.

*** We do believe, however, the risks for January may be somewhat exaggerated, especially the default risk. And while a CR deal will be fraught with difficulties, we think a BCC agreement is within reach and should not be discounted. There are enormous underlying political pressures on both sides to cut a deal on the sequester and FY2014 spending levels despite the compromise-defying ideological gulf dividing the wings of the two parties. ***

A deal, if it is to come about, will depend on the leadership on two fronts.

*** The first is whether House Republican co-chair Paul Ryan can begin to move his bruised Republican conference, including defiant Tea Party dissidents, towards accepting any kind of a meaningful budget agreement built around a ratio of new revenues in return for larger spending cuts through entitlement eligibility reforms and a framework for broader tax reforms down the road. ***

*** The second, crucially, is whether and when President Obama will become more engaged in the negotiations, in particular, by providing political support and cover for Senate Democrat and republican centrists to carve out a bi-partisan space to push a deal towards an agreement. Without at least a public acknowledgment he will sign a  budget conference deal, the members of both political parties may be unable to trade with each other. ***

*** For now, there is no one proposal being circulated, but rather a number of ideas that have been making the rounds across Senate offices. They may, however, coalesce behind a single unifying proposal some time in December. The proposal we think may emerge from the Senate may be initially focused as much on the framework and the process rather than the specific terms of where spending cuts or revenues would be raised, by moving the front edge of the negotiations back to the overall deficit target — perhaps as a percentage of the GDP. ***

*** We do not believe a failure of the budget conference, by itself, will lead to another costly confrontation when the current Continuing Resolution expires January 15. What we do see as far more ominous is the trigger of the budget conference failure to rekindle market fears the world’s largest economy has no political leadership. If the leadership vacuum is unresolved, this sentiment that the U.S. is rudderless may worsen anxieties for yet another market rattling default threat if the debt ceiling is not extended beyond February 7. ***

Diminished Default Risk

One of the more frightening scenarios being weighed by the markets is either another default risk flaring in the run-up to the February 7 deadline to extend the debt ceiling again, or perhaps even worse, a muddled, kick-the-can-down-the-road CR deal in January that only extends the CR another two months to realign the CR with another default threatening need to raise the debt ceiling.

But we believe the default risk is in fact quite low, if not effectively neutralized.

Under the terms of the “Default Prevention Act of 2013,” President Obama was empowered to unilaterally approve an increase in debt limit by signing a “presidential certification” that the extended date for the debt ceiling was essential. Congress has 22 days to reverse the suspension of the debt limit with a Joint Resolution of Disapproval, which it won’t bother with since it requires a two-thirds vote in both the House and Senate to do so.

This mechanism, the so-called “McConnell Provision” that Democrats delight in describing it as in order to “lock it in” as a precedent for debt ceiling increases (and to slightly embarrass the Senate Minority Leader with his Tea Party critics). This “rule” gives Republicans a face-saving way to vote no on a debt increase when they are in fact voting yes, and by writing the increase in the debt ceiling as a calendar date rather than a politically awkward vote for a debt amount.

But ironically in doing so, the Republican political pirouettes shifts leverage from Congress to the White House and allows Treasury to fully replenish its extraordinary measures accounts to tap if needed again. And while not permanent, in using the procedure twice now it is setting something of a precedent that lifts the bar to using the debt ceiling threat as political leverage in the future.

Treasury in the last round went through about $200 billion to keep its funding operations going during the most recent dust-up over the debt ceiling. The wording does preclude the Treasury from stockpiling additional cash, so the debt ceiling will only be increasing by the amount needed to fund obligations during the suspension period.

But still, the debt ceiling is now being increased by whatever amount the federal debt reaches by February 7 – including the restoration of the funds tapped for the extraordinary measures. And so on February 8, barring another agreement to lift the ceiling, Treasury is free to start using its extraordinary measures again.

Treasury will not have the running room it had last year in extending the period of extraordinary measures for nearly a half year, and in this case the absence of another extension of the debt ceiling by February 8, it should still be able to easily meet its funding obligations until at least mid-March.

After that it becomes a bit more uncertain, but there remains a good chance the Treasury could make it to April 15, when it will again be flush with tax receipts. And that, in turn, means a debt ceiling drop dead date may not be at risk of being breached until late May or June 2014.

And not even the Tea Party suicide caucus would be willing to take that battle on within a few months of the November mid-term elections.

A Mule’s Education

Indeed, for all the heated extremism of the GOP’s politically disastrous diversion to defund Obamacare, the Republican leadership on both the Senate and House side is determined to put the focus squarely back on fiscal issues where, lessons learned, the party has far greater unity. As McConnell put it in vowing no more shutdowns and default threats over Obamacare, “there is no education in the second kick of a mule.”

Both sides are approaching the budget conference with major incentives to cut a deal on the FY2014 budget, which has been stalled since last spring. In an environment where political survival — against internal factions within the two political parties — is the prevailing emotion, the “low hanging fruit” of a potential deal is likely to remain on the trees if both parties believe a deal of any size is doomed.

Under the terms of the second sequestered year of the 2011 Budget Control Act, the FY2014 top-line discretionary spending level must be ratcheted down by $20 billion to $967 billion from the current $986.3 billion; and because the first quarter of the fiscal year has been running at that higher level under the current CR, those spending cuts will have to be even deeper in the remaining three quarters.

What’s more, due to the peculiar way the sequester was written, those cuts will be especially painful for the Republicans because almost all of the $20 billion in required cuts falls on defense spending, which must drop from the $518 billion under the current CR to $498 billion.

Already, House Appropriations Chairman Hal Rogers, working off the Ryan budget’s politically expedient adherence to the BCA’s $967 billion spending level, had tried but failed to hit the targets when it came to almost all of the 11 spending bills he and his committee were struggling to write up until they gave up last August.

Although Democrats are obviously hoping to use the Republican discomfort with defense spending cuts as leverage, the distance from their $1.058 trillion proposed discretionary spending level gives them plenty of incentive to jettison the sequester as well.

But for all the assumed leverage, the GOP is highly unlikely to trade some more defense spending for their key success in the near three years of fiscal wars, the BCA’s $2.1 trillion of spending cuts, half of which is now falling under the sequester sword in the wake of the Super Committee failure.

The obvious solution is to simply split the difference between some revenues through the closure of tax loopholes both sides already agree to in principle, and a few hundred billion in entitlement spending cuts such as the shift to the chain weighted index that was already included in President Obama’s FY2014 budget proposal.

But the entrenched political positions, more or less set by their ideological wings, is all but certain to mean the path to a deal on the FY2014 budget and the sequester will take several “zigs” to get to a final “zag” whose key turns, we think, will be driven by House Budget Committee Chairman Ryan, and ultimately, by President Obama.

Pivotal Ryan and Obama Leadership

Ryan himself as well as Sessions, the GOP’s chief Senate budget negotiator, voted against last week’s budget deal. Their no votes testify to the deeply rooted conservative Republican opposition to tax revenue increases of any kind as well as the need to maintain credibility with the still defiant Tea Party. But those no votes may also provide them with crucial credibility in selling the final terms of any agreement cut with the Democrats.

Along those lines, for example, we expect Ryan and the leadership to use the weeks in November to neutralize as much of the Tea Party faction as they can by folding their ongoing Obamacare demands into the entitlement reforms. Indeed, Ryan, for all the ideological demands of his party, will have considerable more sway room to maneuver the committee, as he enjoys the solid backing of the GOP leadership.

But in the end, we suspect Ryan will only be able to steer the BCC and his Republican counterparts so far towards a deal without at least a minimum of movement from the Democrats, and in particular, Senate Majority Leader Harry Reid.

Part of the problem is the imbalance within the committee. Murray, Ryan’s Senate counterpart, has far less freedom and can only go as far as Senate Majority Leader Reid will allow, which isn’t going to be much.

Reid drove the hard-line Democratic negotiating stance in the shutdown battle, even to the point of keeping President Obama to the sidelines, and sees no political reason to relent on entitlements if the Democrats can continue to drive a wedge between the GOP mainstream and the Tea Party dissidents.

But whether the President would stick to such a hard line stance, or whether he will see light in the possibility of cutting a deal to bolster his legacy beyond the troubled Affordable Care Act is the question. Our sense is that it is likely if the opportunity — and need — arises; at some point after the Thanksgiving break, and perhaps not even until the one month interval between the BCC deadline and the actual January 15 CR deadline, we do believe President Obama will step into the breach to broker the last stretch of the budget negotiations.

In particular, there is a not insignificant number of centrists Senators, Democrats and Republicans alike, and women in particular who are again already quietly working behind the scenes to carve out a bi-partisan space to make a deal work, assuming it has been edged a bit from its extremes. Again, the potential to move to the center, and the incentives for doing so, are real. What many on the Hill believe is lacking, still, is leadership.

For instance, the question circulating around the Senate corridors is centering around what the potent political cover and support of the presidential bully pulpit shows up in full force? On that note, recall the self-described “Gang of 30” from last year who in the end never showed up for lack of presidential cover but who were making their first forays into the compromise before the agenda descended into the extremes of the fight over the fiscal cliff  (SGH 7/12/12, “US: Fiscal Policy, Thelma and Louise Style”).

We will in fact be watching closely to see whether the budget conference turns to discussions of metrics, frameworks and process rather than the specific terms of where spending cuts or revenues would be raised. Modest changes in entitlement spending can be delivered through minuscule trims — reduced as little as one-half percent — in all spending categories except debt service.

But in the end, if it happens, the key breakthrough, we think, will be a budget framework based around ratio of revenues (via tax reform?) to overall spending cuts somewhere around the four to one split first laid out in the Simpson-Bowles proposal.

If, that is, a deal is to take shape.

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