US Budget Deal Analysis
Fundamentals Update as at 18 December 2013 by Lorenzo Beriozza
The plan effectively substitutes later deficit reduction for current increases in spending by relaxing the sequester caps for two years. In fact, about $45 Billion of the easing in budgetary authority happens in FY2014, with another $19 Billion in FY2015. This change actually pushes up the budgeted discretionary spending in 2014 to $1012 Billion; whereas authorised discretionary spending was scheduled to fall from $988 Billion in 2013 to $968 Billion in 2014, according to the 2011 Budget Control Act.
The key term here is “authorised spending.” The various fiscal plans determine “budgetary authority”: the annual limit on how much a department or agency is allowed to spend. But budgetary authority can be carried over into subsequent fiscal years, in fact, that is essential, since the federal government bookkeeping doesn’t distinguish current from capital spending: it’s all treated as current. For example, the budgetary authority for the Pentagon to purchase a new ship or plane happens in one single year, but the actual outlay is spread out over several years thereafter. The same is true for any multi-year program or expense in the non-defense sectors.
To figure out the impact on the economy, one needs to estimate actual spending, not just changes in budgetary authority. The Murray-Ryan deal would add nearly $45 Billion to the FY 2014 budget authority, but the increase in FY2014 spending is estimated by the Congressional Budget Office (CBO) to be just $26 Billion; or about $32 Billion for the calendar year 2014. The rest is spread out over the next five years. In other words, the deal would add back about 0.2pp of direct spending in 2014. That said, the main reason the sequester did not have quite the adverse impact that some had feared; for example, a much shorter and smaller furlough is that many departments and agencies effectively were able to spend down unused prior budgetary authority. That option was missing for 2014 before the Murray-Ryan plan, meaning the potential adverse impact on the economy of the 2014 sequester could have been larger than anticipated. The Murray-Ryan plan buys roughly a year and a half of sequester “relief,” but sets up a bigger drop-off in budget authority and thus spending from 2015 onward. A recent study by the Bipartisan Policy Centre concludes that the Defense Department may face an even more challenging sequestration limit in 2015 and 2016. In effect, this plan would just postpone the pain, and it would be greater when it finally hits. Thus, the deal may have bought a near-term reduction in budget uncertainty, eliminating the risk of another shutdown in the next year or two, in exchange for more challenging battles not too far down the road.
Of course any optimism over the deal is for naught if it cannot pass, and there is opposition on both sides. Neither side got its legislative priorities and that was by design. In fact, the bill’s main sponsors attempted to promote it to their fellow party members by arguing that no one was happy with the outcome. Ryan told his Republican House colleagues, “in divided government, you don’t always get what you want” an odd sales technique, for sure.
Democrats expressed some opposition to the lack of an extension of unemployment benefits (more on this below) and the view that federal workers bore too much of the deficit reduction. Of the $85 Billion in offsets, less than half comes from a grab bag of slower spending, increased fees, and changes to government employee pensions. More than half occurs in the final two years (in 2022 and 2023) due to an extension of 2% cuts in payments to Medicare providers. Interestingly, that appeared to attract fewer objections from Democrats. Rather, many Republicans complained that the increase in spending budget deficits will be slightly larger in 2014 and 2015, in line with the reduced impact of the sequester (but the savings is far in the future). What’s to stop some later deal from overturning those planned cuts? Ryan and House Speaker John Boehner responded that the Medicare changes are in mandatory, not discretionary spending, which should make them more durable. Time will tell.
Some Republicans also objected to any backing away from the sequester, and characterised the increased fees (such as a jump in TSA airline surcharges) as just hidden taxes. As a result, around two dozen conservative groups came out in public opposition to the plan, including Heritage Action, Americans for Prosperity, and Club for Growth. So too did a number of Republican Senators, among them Minority Leader Mitch McConnell, Marco Rubio and Rand Paul. But Democrats have enough votes to get the bill through the Senate – the question is the House. Over the past few years, most major fiscal agreements have been passed in the House with a minority of the majority party’s support. In fact, House Republicans on average have voted nearly 2-to-1 against many of these deals, including the most recent to end the shutdown and extend the debt limit in October. That vote had 87 House Republicans in favour and 144 opposed. A similar split vote is to be expected this time too, with the bill ultimately passing in the House with bipartisan support but more Republicans opposed than in favour.
Some commentators have suggested that the bipartisan deal is a particularly positive sign because it shows Congress is able to move beyond the brinkmanship moments of the past several years. The strong opposition even to the very modest scale of this plan undermines that perspective. A deal was possible precisely because it was small, sidestepped more contentious issues, and gave few concessions to the other side. It is hard to see this deal as a Blueprint for subsequent agreements. Indeed, this deal may have plucked the last of the low-hanging fiscal fruit, in our view. Subsequent budget negotiators may find it increasingly more difficult to avoid the very divisive issues of tax and entitlement reform where big changes are needed if more permanent progress on reducing long-term budget deficits is to be made. And there is no vast consensus on this deal being a sign of the end of political polarisation in Congress.
The other challenge from this deal is that several other “mini-cliffs” are left unresolved. These could offset much of the benefits of the bipartisan deal.
- The farm bill: Disputes over several issues has held up renewal of a farm bill. One unusual consequence this year is a large jump in the price of milk as the law reverts to price supports from over half a century ago as much as 50% to 100%, taking the price of a gallon of milk to $6 or $7. This so-called “dairy cliff” is not trivial. Americans spend around $25 Billion on fresh milk annually and another $40 Billion on processed diary goods. Assuming some substitution effects so that total spending on diary goods rises by just one third still implies a $22 Billion hit to consumers’ pocketbooks.
- The Medicare “doc fix”: Every year, Medicare reimbursement rates for doctors are poised to reset to much lower levels, and every year Congress comes up with a last minute “fix.” In 2014, CBO estimates they would decline by 23.7% in the absence of legislative action. Another one-time fix would cost around $20 Billion; a “permanent” fix (that is, over the 10-year budget window) would cost in excess of $135 Billion according to the CBO.
- Extended unemployment benefits: The Federal-sponsored EUC (Emergency Unemployment Compensation) program, created in 2008, is set to expire at year’s end. That would mean an immediate cut to zero benefits for around 1.3 million workers, and another 800,000 whose benefits would run out in the first half of 2014. The CBO estimates that it would cost about $26 Billion to extend the program, and that in turn would add about 0.2pp to GDP growth relative to expiration.
In the end, it is likely the farm bill and doc fix will be enacted by Congress, although perhaps retrospectively. Another extension of unemployment benefits is less likely; the base case is a short-term extension of just a few months, meaning some small drag upon the economy. But none of these are guaranteed. Taken as a whole, the uncertainty over fiscal policy heading into 2014 is still high even with the recent budget deal.
Also unresolved by the Murray-Ryan plan is the debt limit, which will be reached again on February 7. The drop-dead date for raising the debt limit is later, as the Treasury can once again invoke “extraordinary measures” to postpone when it actually runs out of cash. Treasury Secretary Jack Lew has said that would happen in March; CBO estimates it is possible that the Treasury will be able to make it to the April 15 tax date, which then allows the government to operate another month or two before a hard limit is reached. How the Congress intends to get a debt ceiling deal done is unclear: after this bipartisan bill, it may be difficult for Republicans to turn around and insist on additional spending cuts to rise the limit. There is confidence that neither party wants to seriously risk a debt default, but debt limit increases are not politically popular, and 2014 is an election year. The endgame here is also uncertain.
Overall the Murray-Ryan plan is mostly good news. If adopted it may add a few tenths to 2014 GDP growth as the sequester is scaled back. And it likely means little chance of another government shutdown in the next year or two. But it doesn’t deal with a number of other “mini-cliffs” on the fiscal side, each of which would yield a drag that is similar in size to the boost expected from the bipartisan deal. There is also insufficient evidence that this deal is the sign of a new spirit of bipartisanship in Washington DC.
Source: Merrill Lynch Bank of America
