No sooner had the bipartisan debt ceiling deal negotiated by President Joe Biden and House Speaker Kevin McCarthy been signed into law than the aptly named Fiscal Responsibility Act was met with applause from Washington’s chattering class.
“The FRA is the largest deficit reduction bill in well over a decade, and it passed with support from both parties,” said Maya MacGuineas, president of the Committee for a Responsible Federal Budget. “The FRA is likely to generate at least $1 trillion in savings, and could save as much as twice that if appropriators take its targets seriously. That’s a very good starting point; now more work will be needed.”
Added the Bipartisan Policy Committee: “The BPC applauds President Biden, Speaker McCarthy, and congressional leadership for crafting a bipartisan agreement addressing federal spending and avoiding a potentially disastrous default on our obligations. This kind of compromise is exactly how divided government should work.”
But with barely a week to reflect on the achievement – arrived at after plenty of political gamesmanship and warnings of economic catastrophe should the government default on its debt – a new reality that an era of exuberant spending could be over is setting in. That, along with the predictable calls for new programs that could undo some of the law’s promises.
One realization is that the days of easy money and expansive federal spending ushered in during the coronavirus pandemic may well have ended. Another is that the law does little to tackle the underlying structural imbalances between government spending and revenues, dealing with only discretionary spending outside of defense and not touching programs such as Social Security and Medicare.
And finally, the reality that the law sets up another battle over the debt ceiling in two years, when a new Congress and perhaps a new president will face many of the same issues as well as the expiration of certain tax breaks that were enacted in 2017 during the term of former President Donald Trump.
“Setting aside the specific figures, we think this bill marks an important inflection point in federal fiscal policy,” Wells Fargo economists Michael Pugliese and Karl Vesely wrote after the deal was struck. “The past several years have been marked by highly accommodative federal fiscal policy. This era may be coming to an end as federal fiscal policy is shifting to a more neutral stance.”
The Congressional Budget Office estimates the debt ceiling agreement will reduce budget deficits by about $1.5 trillion over the next 10 years. Many private economists say it will reduce overall gross domestic product by 0.1 to 0.2 percentage points. That’s a drop in the bucket of an economy expected to produce an annual GDP of $26 trillion this year.
And it’s not the only drag on economic growth underway, as the Federal Reserve has also raised interest rates by 5% in total over the past year and continues to reduce the assets of its balance sheet by up to $95 billion a month.
Add in that the Treasury will now be issuing around $600 billion-$700 billion in new debt to make up for the time it was not raising funds during the standoff and it is likely that the economy will see a drying up of excess liquidity.
The debt ceiling agreement does not appear to be the last word on some spending, like on defense, where Senate Majority Leader Chuck Schumer and Minority Leader Mitch McConnell secured votes from military hawks by agreeing to a statement that the bill would not prohibit additional defense of emergency spending. But where McConnell has expressed openness to additional spending, McCarthy has been firmly opposed to a defense supplemental after the debt limit agreement was reached.
The political dynamics of other spending battles to come were also on display this week as House Republicans who were critical to McCarthy’s elevation to speaker managed to scuttle a vote on the rule governing debate over bills aimed at restricting the Biden administration’s ability to regulate or ban gas stoves that have widespread GOP support. The conservative rebellion came in opposition to the debt ceiling deal, where they argue McCarthy did not follow through on his agreements.
Adding to the precarious spending situation was the new law’s requirement that Congress approve the 12 annual appropriations bills this year or face automatic cuts to both defense and nondefense spending. It’s a lift that hasn’t been achieved in decades, with plenty of room for error.
“Although the conservatives probably lack the votes to block the spending in the House, they could make life miserable for House Speaker Kevin McCarthy by turning up the pressure on him from the Republican base,” Brian Gardner, Stifel chief Washington policy analyst, wrote on Wednesday. “The dynamics in the House mean that a government shutdown in the fall is not impossible, although it is less likely than it was a few months ago.”
Meanwhile, reports have been circulating about the next big push from House Republicans – a package they say would boost economic growth by reviving expired tax breaks. While the package has little chance of becoming law, with a Democratic president and Senate, it is an opening salvo in what is expected to be a major battle over taxes in 2025 when tax cuts for individuals and a reduction in the corporate income tax passed during the Trump administration in 2017 are set to sunset.
“What do House Republicans have planned?” House Democratic Caucus Chairman Pete Aguilar said at a news conference this week. “This month they have told their members that they are going to mark up a over $3 trillion tax cut that would help the wealthy and the well connected at the expense of everyone else. After crowing about deficits and debts over the last few months, we know that this is exactly what they had in mind.”
With the legislation, Republicans were reportedly considering how to extend the Tax Cuts and Jobs Act of 2017, which reduced the corporate tax rate, and is set to sunset in 2025.
But doing so would seem to fly in the face of the effort to reduce the deficit. Estimates released last month by the Congressional Budget Office project a more than $2.5 trillion price tag for an extension through 2033.
“I think they’re having fun over there but I don’t know that it’s serious legislating,” Sen. Sheldon Whitehouse, chairman of the Senate Budget Committee and one of the lawmakers who requested the CBO estimate, tells U.S. News. “At the moment, I think the problem with the tax code is not that billionaires and rich corporations don’t have enough breaks.”
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Even so, Republicans argue that the possible tax breaks and the package at large would boost the economy with wage growth and relief for businesses.
“I think we will be looking at offsets there, but I think we’re going to look at how do we bring relief to the American people and families and that’s what we’ll be focused on,” HuffPost quoted Rep. Darin LaHood as saying.
Some have speculated that Democrats might sign on to some return to a more accelerated rate of research and spending development deductions, but only if they can get what they want in return, chief among those wants being increases to the Child Tax Credit, which expired in 2021.
All the while, the debt is on a trajectory to increase in any case due to rising interest rates. The U.S. enjoyed a 14-year period when interest rates were low following the financial crisis of 2008. Then came COVID-19 and the massive spending by Congress and extraordinary stimulus of the financial system by the Fed.
However, the new environment of “higher for longer” interest rates anticipated by the markets means the cost of servicing the government’s debt is going up.
“The U.S. is in a very vicious cycle which is difficult to break,” says Johnathan Owen, portfolio manager at TwentyFour Asset Management. “The U.S. doesn’t have the levers they need to stimulate growth.”
Owen points to estimates from the CBO that forecast the federal government’s borrowing costs, interest on the debt, will grow 35% this year to $645 billion, up from $475 billion last year and $325 billion in 2021. Moreover, it is projected to reach $1.4 trillion a decade from now. Measured as a percentage of tax revenues, it will reach the 20% level by 2033 – double the level of just last year.
“The fastest-growing expense for the federal government is not entitlement spending programs but instead interest on the debt,” says Harold Furchtgott-Roth, a former Federal Communications Commissioner and former chief economist of the House Commerce Committee in the mid-1990s.
With both sides dug in on their respective positions – Democrats loathe to cut entitlements and Republicans seeking to increase defense spending – it leaves little room for a bipartisan compromise on narrowing the trajectory of debt by any meaningful degree.
“No one seems responsible to solve the problem,” Furchtgott-Roth adds. “It’s a sad situation we’re in.”
McCarthy for months employed an analogy – albeit somewhat flawed – to illustrate to Americans how hiking the debt limit without spending cuts would be irresponsible.
“If you gave your child a credit card, and they kept maxing it out to the limit, you wouldn’t blindly just raise the limit,” McCarthy reiterated over the months-long debt ceiling fight.
But with the spending caps agreed to in the debt deal, Congress is expected to be pinching pennies for the foreseeable future. To extend the analogy, while the limit has been raised, the credit card effectively has been revoked.
