January 13, 2023

Thought of the Week

A new year. A new Congress. A new Speaker. New committee assignments. Renewed calls for fiscal discipline. We’re hearing a lot about budgetary concerns in Washington these days. Think tanks are holding programs on the debt limit; trade associations are setting meetings with appropriators; consultants are releasing forecasts of expected spending; the media is reporting on the debt and deficit; and even the Supreme Court is getting in the act—taking up the Biden administration’s student debt relief program next month. Similar to a family budget, in at least one way, the federal budget is made up of both incoming revenue and outgoing spending. While annual projections are all over the map, rarely do you see what would truly be required to balance the federal budget. No doubt, that aspirational fiscal goal has become much more difficult to reach post-pandemic. According to the nonpartisan Committee for a Responsible Federal Budget, balance cannot be achieved in a decade’s time if revenue, defense, and certain other parts of the budget are excluded from the solution. In fact, the situation is so dire that in order to achieve balance within a decade, all spending would need to be cut immediately by one-quarter, growing to 85% if defense, veterans, Social Security, and Medicare spending were off the table. These cuts would be so large that they would be the equivalent of ending all non-defense appropriations and eliminating the entire Medicaid program. While past efforts to reach balance often relied on unrealistic cuts, unspecified savings, rosy economic assumptions, and budget gimmicks, the federal deficit is now on course to reach $2.4 trillion, or 6.6% of GDP. Although the exact amount of additional revenue and savings needed for budget balance is uncertain, it is estimated that achieving balance would require $14.6 trillion of deficit reduction through 2032. To achieve that amount of savings without additional revenue, all spending in 2032 would need to be cut by 26%. For a sense of magnitude, applying this cut across the board would mean reducing annual Social Security benefits for a typical new retiree by $10,000 to $13,000; laying off 1.1 to 1.4 million federal employees (more than two-thirds of the civilian workforce if the military were exempted); and removing 20 to 25 million people from Medicaid eligibility. These figures do not include additional savings that would be necessary if policymakers choose to extend the $3 trillion worth of tax cuts that are set to expire in coming years. To get a sense of how challenging achieving balance in 2032 by controlling spending alone would be, consider that it would require doing one of the following: 

  • Eliminating all defense and non-defense discretionary spending programs; 
  • Cutting Medicaid spending in half while eliminating all other mandatory spending outside of Social Security and Medicare; 
  • Eliminating all non-defense discretionary spending and ending the entire Medicaid program; 
  • Repealing Medicare, all income security programs, and all refundable tax credits; or 
  • Discontinuing all Social Security retirement and survivors’ benefits.  

Wanting to balance the budget is an admirable goal. However, the path to balance is virtually impossible if major parts of the budget and tax code are exempt from change. The public needs to be aware and policymakers need to be forthcoming about the real policies required to begin reducing deficits. The first step may be to avoid any actions that worsen an already unsustainable fiscal situation.


Capital Alpha Offers Insight Into How the Debt Limit Process May Play Out. One good thing about the chaos on Capitol Hill last week is that it gives insight into how the debt limit will eventually be extended later this year. Because House Republicans are not unified, they will eventually be forced to accept a clean debt ceiling extension from the Senate, possibly firing a Speaker in the process. When the time comes, Senate Democrats will pass a clean debt limit extension. Senate Republicans will “cooperate” with Democrats by providing just enough votes to pass a motion to proceed. The House will pass the Senate debt limit extension with both Democrat and Republican votes. The Republican Speaker who presides over this vote will probably lose his seat as a result. The only question is when this happens. One thing that is certain is conservative Republicans in the House and Senate will get none of the policy concessions, intended to check discretionary and entitlement spending, they want. There will be no credibility in a protracted debt ceiling standoff as conservatives will be in no position to negotiate anything. Ironically, one of the things that will speed this outcome is the new rules package. It is a reasonable package, most of which was going to be adopted anyway, which intends to return the House to the way it operated in an idealized classical past, prior to 1995.

Conference Board Continues to See Increased Borrowing Costs and Inflation Leading to Recession. December’s CPI readings showed continued inflation relief and are consistent with forecasts that topline, year-over-year CPI peaked in Q2 2022. However, the readings remain far too high. The improvement in the headline figure was largely driven by lower energy prices, although prices for many core goods also declined. Core inflation ticked up slightly due to rising prices in services, like shelter. As the housing market cools over the coming months, shelter prices should gradually follow suit. Companies should expect the Fed to hike rates by 25 bp on February 1, pushing the Fed Funds window to 4.50-4.75; a final 25 bp hike in March; and then elevated rates throughout the remainder of 2023. Even with this degree of monetary policy tightening, key consumer price indexes, specifically the personal consumption expenditure deflator, will remain above the 2%t target until late 2024. Borrowing costs will also remain elevated in the near-term as the Fed battles inflation. These two forces will weigh on consumer spending and business investment over the coming months and likely trigger a U.S. recession.

Eurasia Group Believes House Rules Package Sets Up Near Impossible Spending Tasks for Congress. Earlier this week, the House of Representatives passed its rules package establishing the legislative process in the lower chamber; the rules reflect concessions made by Speaker McCarthy (R-CA) to the conservative House Freedom Caucus (HFC) to earn their votes in last week’s speakership election. Some of these concessions take the form of major spending cuts as the rules envision capping appropriated spending at FY22 levels, 8% less than the recently enacted $1.7 trillion for FY23. Reaching this figure will require a 10% cut to national-security programs for FY 24 if evenly apportioned across defense and non-defense budgetary items. Because House defense hawks, Democrats, and Senate Republicans are unlikely to approve such cuts, the most likely fiscal outcome for FY24, which begins October 1, is a continuing resolution at FY23 levels. Assuming inflation remains elevated, this would be a real cut in appropriated government spending, which makes up about 1/3 of the federal budget. Although the rules package was designed to take power away from appropriators and give it to the most conservative members, that power is worth nothing if a majority of votes cannot be found. Anything passed by the House will be substantially reworked by the more compromise-oriented Senate. This has implications for the debt limit, which will become a crisis in Q3—more than likely, the House will pass a debt limit that includes cuts to government spending with no votes from the Democrats, while the Senate finds a bipartisan compromise, which is eventually accepted by the House at the last minute.


ESG Backlash Not Affecting Sustainability-Related Investments. Key insights from a Conference Board report capturing the perspectives of 1,131 C-Suite executives show that almost 60% of CEOs globally and 71% in the U.S. expect no significant impact on their company’s sustainability-related investments during 2023 due to the ESG backlash. Globally, just 21% and 17% in the U.S. say they will refine priorities or shift the focus of efforts this year because of stakeholder backlash. This makes sense: as companies make sustainability an integral business priority, they are less likely to make changes because of political or other stakeholder objections.


“Is the White House going to be raided tonight?”—Rep. James Comer (R-KY) on reports that President Biden kept classified documents from his time as vice president in a personal office.

“You can’t make this crap up,” Rep.-elect George Santos (R-NY), ironically, on the Speaker of the House vote drama.


The smoke-filled rooms of American politics have returned. Republicans, now in control of the House, lifted the smoking ban on the House side of the Capitol, a rule that Rep. Nancy Pelosi (D-CA) implemented in 2007 when she was speaker. Although the D.C. government prohibits indoor smoking, Congress possesses legislative superiority, allowing it to ignore local laws.


Inflation Expectations—Whose Team Were You On? The description of inflation as “transitory” became highly politicized, especially as members of the Biden administration adopted the term. The opposing view, sometimes called #TeamPermanent or #TeamPersistent, was more often, although not exclusively, promoted by right-leading economists and media. Although it’s an open question as to the extent the #TeamTransitory vs. #TeamPermanent debates shaped and polarized inflation expectations, survey data shows that Democrats’ inflation expectations remained virtually flat throughout 2021 and 2022, while Republicans’ expectations rose sharply. In other words, Democrats and Republicans sorted extensively into #TeamTransitory and #TeamPermanent.

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