US: The Fiscal Road Map

Published on April 9, 2019

The next phase of the political brawl to pass a budget that would take US federal spending through the November 2020 elections is taking shape this week as House Speaker Nancy Pelosi struggles to find the 218 votes she needs among her Democratic majority to pass the budget bill reported out of House Budget Committee last Wednesday. 

The “Investing in People Act of 2019” would boost discretionary outlays by more than $100 billion in the two fiscal years beginning this October, starting with a $34 billion increase in non-defense spending and a $17 billion increase in defense spending in FY2020 over 2019 levels. For the highly vocal progressive wing of the Democratic House, non-defense spending needs to be higher still, by at least another $33 billion.

*** Two aspects of the House budget debate stand out. The first is that while the numbers are already rapidly becoming something of a blur, the level of the proposed spending increases is for now not as important as the strong political signal the sequestered spending caps of the 2011 Budget Control Act will almost certainly be busted again, and; second, as underscored by the progressive demands, we see a two-step political dynamic unfolding in which intra-party differences will be overcome with higher non-defense spending now to clear Democratic hurdles, and higher defense spending later to clear Republican objections. ***

*** In other words, while the final tally won’t become clearer until after summer, we still believe the path of least political resistance to a budget will be through higher federal discretionary spending in the next two fiscal years, perhaps even equaling the fiscal stimulus of the 2018 Bipartisan Budget Act that helped to power the near 3% US growth last year (SGH 3/7/19, “Capitol Hill: The Bar Tab is Open”). We also think it probable the House leadership may attach a bill to increase the debt ceiling as a “must pass” amendment to ramrod the higher FY2020 spending bills into law before the first week of October. ***

*** This “fiscal accelerator” scenario is guided, and limited, by two assumptions: first, that Speaker Pelosi will hold the stronger negotiating hand come September when the parallel House and Senate budget tracks will need to be aligned into unified spending bills or probably another Omnibus package; second, that President Trump will not veto a deal on Capitol Hill that boosts both non-defense and defense spending, as it would ensure a second surge of fiscal stimulus going into the 2020 elections. There remains, however, a tail risk that either, or both, these assumptions collapse, so a close monitoring into September is warranted. ***

“Shared Destinations”

At the outset, it is probably worth noting that the higher federal discretionary spending we think far more likely than not isn’t being driven by a sudden embrace across Capitol Hill of the so-called “Modern Monetary Theory,”or some carefully weighed macroeconomic policy tipped towards fiscal over monetary policy to drive growth and demand.

Higher FY2020-2022 fiscal outlays are being driven by the twin, and separately throttled, engines of pure party politics, what we would call a “shared political destination” rather than a budget result coming about through hard fought, carefully crafted compromises (a point we first made last year in SGH 9/10/18, “US: Midterms, Trade, and a “Fiscal Accelerator”).

Democrats, now back to controlling the House and with the means to politically deliver on so many of the pent-up spending demands of their constituencies, are highly certain to pursue spending levels and programs that reflects their political agenda priorities in non-defense discretionary spending and social programs. Speaker Pelosi believes that her newly won majority was created mostly by promises to boost federal health care spending, and less so as a check on President Trump.

The House leadership, in other words, is hardly going to try to tighten spending and alienate their core constituencies in some vague notion of timing a fiscal tripwire to growth next year in the hopes somehow of denying an economic boost from which President Trump will run his own re-election bid in 2020. 

And in a similar fashion, while President Trump may feel under siege in the flood of House Democratic subpoenas and investigations, or by the eventual release of the Mueller report, we would not necessarily envision his turning to a bipartisan out-reach to “work with” Democrats; the President’s political instincts, we think, will more or less be to avoid a fiscal policy that could in any way markedly slow growth going into November 2020. 

And on that note, in its most recent projections, the Congressional Budget Office is estimating  that year over year growth would slow by at least 0.6% to 1.7% in 2020 if the 2011 BCA’s automatic spending cuts of some $126 billion, or 10% from this year’s current spending levels, were imposed in the new fiscal year. 

A Seeming Senate Steer to Austerity

The Senate Budget Committee moved first in the initial round over the 2020 budget battles, managing to pass a budget resolution on an 11-8 vote along party lines that slashes discretionary spending by $126 billion, as well as additional cuts to spending on Medicare, Medicaid, children’s health insurance, and Affordable Care Act subsidies to states. 

The Senate resolution also included an amendment extending the 2017 tax cuts for individuals beyond its current set expiration in 2026. But the resolution was also set for only five years, in effect, to avoid showing the scale of the deficit in the latter five years of the more traditionally scaled ten-year baseline. Interestingly, it also included a boost in taxes to help fund the Highway Trust Fund. 

The Senate’s budget resolution is non-binding and doesn’t carry the force of law. It is instead, like a House resolution if the Democrats had managed to pass one, largely a political document to frame budget political priorities. In this case for the Republicans, it steers towards deficit reduction.  

In that sense, the Senate GOP budget resolution sought to mirror the President’s unexpected austerity budget “blueprint” presented in late February: a 10% cut in non-defense spending — which we believe the Senate Republicans know is destined to be rejected — in order to bring the 2020 spending back down to the levels under the sequester caps of Budget Control Act of 2011. 

At the same time, however, the White House proposed a substantial 17% increase in defense spending to a record $750 billion, with most of the increase, some $165 billion, diverted off-budget into the Pentagon’s Overseas Contingency Operations fund, more than double the size of the OCO even during the height of the Iraq and Afghanistan wars.

The President’s budget bears zero chance in the House, nor does it bear much chance of even passing in the Senate, where scores of centrist and defense hawk Republicans, as well as the Pentagon itself, objected to the excessive use of the off-budget OCO sleight of hand. 

The House: Busting the Spending Caps

The Democratic-controlled House Budget Committee, on the other hand, opted to avoid a divisive budget battle altogether that would have invariably put on full public display the splits between the party’s progressive wing and the handful of fiscal and defense conservative Blue Dog Democrats that remain. 

Instead, in a 19-17 vote along partisan lines, the Budget Committee last week passed the “The Investing in People Act of 2019” which focused on providing only the top line spending targets, namely, a political testimony to bust the sequester caps. 

As it looks to be playing out, Speaker Pelosi’s hopes of avoiding an early intra-party skirmish may come to nought as the leaders of her progressive wing are threatening to vote against the budget bill unless more non-defense spending is added into the bill, along with a few other amendments. 

For now, the House bill would raise non-defense discretionary spending by 5.7% to $631 billion in fiscal 2020 and to $646 billion in fiscal 2021, while defense discretionary spending would rise by 2.6% to $664 billion in 2020, and to $680 billion in fiscal 2021. 

To secure a solid 218 plus vote on the bill, then, Speaker Pelosi will more likely than not have to scale up non-defense spending, perhaps by another $33 billion judging by the initial chatter among the House Democratic caucus in recent days. If that works, the higher spending totals would then be passed on to the House appropriators, whose subcommittees will work from those numbers in the coming months to draft legislation for the 12 spending bills.

Where the Leverage will Lie

House Democratic appropriators, working off the much higher numbers, will have a far higher prospect for passing their respective spending bills compared to the Senate appropriators, who will be struggling we suspect to secure enough Republican votes in their subcommittees to sign off on deep spending cuts going into an election year. 

Passing any of the bills on the Senate floor, where Majority Leader McConnell knows that he could lose six or more of his Republicans — especially among the dozen or more up for re-election in the purple and blue states in 2020 — will be a tall order. With more bills in hand, and with more to prove, we suspect Speaker Pelosi will have an upper hand in the eventual budget negotiations.

Adding to Pelosi’s leverage, we think, the House bill as written includes a little noticed but critical cap on the OCO to no more than the 2019 levels of $69 billion — “to avoid further misuse,” as the Budget Committee Chair noted about its inclusion. Speaker Pelosi, we understand, in seeking to bust the cap on defense spending despite the objectives of the progressives who demanded a cut in defense outlays, will use the OCO cap as a key leverage point to the negotiations with the Senate Republicans in September. 

On the other hand, some leverage will come into play to favor the Republican demands as well, but always pointing to higher spending. Senate Majority Leader McConnell and the Senate Republicans, for instance, are likely to reverse the Democratic negotiating template — the dollar for dollar increases for their favored non-defense spending to the Republican-desired defense spending — and use it against the Democrats. 

We would suspect that will indeed be coming into play by the time of a second round of upping the spending ante when the two sides invariably go to conference to sort out a budget deal in September — a deal that will have as an imperative the need to also increase the debt ceiling hanging over them.

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