SUMMARY
One of the problems with the periodic debt limit drama is that heated debate over an accounting mechanism deflects serious consideration of Washington decisions forcing that bookkeeping. The following chart tells many tales but on whole it depicts a nation that has run out of fiscal wiggle room, not capacity. Capacity can be generated via decisions such as the pandemic response, or the determination to land on the moon. That wiggle room is evaporating due to the gap between revenues and expenditures. Entitlements are required by current law and net interest outlays are required by an equally sticky contract with the bond market which rising rates renders more burdensome.
Fiscal Policy Math is Simple, Changing the Answer Isn’t
Spending above the CBO baseline added at the end of this Congress and the two years of the next is unlikely to materialize, saving two exceptions. (1) If (contrary to most expectations) a meaningful recession is nigh, automatic stabilizers and revenue contraction will worsen fiscal imbalances implied in the graph above. (2) Possible but much less likely is bipartisan agreement to cut revenues and add to entitlement program commitments. Since 1990 the quickest and biggest spending bumps were in response to economic shocks (GFC, pandemic).
Discretionary increases in 2001–2007 were largely ‘paid for’ by 1995–2000 from hyper growth and a consequently hot equity market. The middle line, our first prong of the narrative, is the well-known story of shrinking discretionary spending since 2010. Mandatory outlays driven by demography began reshaping the spending baseline a few years before then, after the first round of baby boomers began retiring. The second prong is the rebound in net interest costs due to higher rates and mandatory spending.
The third prong not many voters or lawmakers want to hear about much less discuss, is revenues. CBO projects that during the ten years from FY23-32 revenues are basically flat at an average 18.1% of GDP per annum. Fiscal policy is the most basic political expression of who gets what when. Accounting for all of this is important but not as important as political disincentives to address the front-end decisions that receive far less attention.
The modern history of president’s first years being the timeframe for major fiscal packages goes back to Ronald Reagan and includes the current Chief Executive. The last significant deficit reduction program came in 1993, Bill Clinton’s first year. This pattern is the main reason we doubt the current policy trajectory of rising deficits and debt could be reliably addressed until 2025. (We believe the pattern holds in the event of a second Biden term.) Of all the implications of this call, an impatient bond market (as was the case in 2H92–1H93) tops the list of risks.
Lame Duck Update
President Biden yesterday was active on the legislative front. He met with Senate Appropriations leaders to gauge whether an omnibus spending bill can be enacted by December 16, or if a short-term extension of the existing continuing resolution would be necessary. This bill drives the calendar. The omnibus would be the vehicle for tax extenders. Advocates of renewing an expanded, refundable Child Tax Credit hope Congress will use the full length of this Congress, officially January 3, 2023, to increase odds of adding this provision to the omnibus.
The White House also announced support for adding Senator Manchin’s energy permitting bill to the National Defense Authorization Act. Our sense remains both an omnibus and the annual NDAA are more likely to become law by December 23 or so, but this is a fluid set of negotiations.
