In-depth: Republican US Congress? Big budget showdown unlikely

We find it unlikely a Republican Congress will re-instigate the budget showdowns of recent years. 2015 is not an election year and the risk of brinksmanship may edge up. But we believe many Republicans want to avoid conflict, with a view to appearing responsible prior to the 2016 election. The party was disproportionately hurt in polls during the 2013 shutdown. Last December’s budget bill showed there is room for bipartisan compromise. The deficit is already low. It would be tough to call for more austerity without axing defence personnel or popular entitlement programmes.

But some issues remain unresolved

Congress needs to authorise 2015 federal spending by December. The deadline to extend the debt ceiling is expected in March. Furthermore, existing spending caps are likely to have to be raised. While it is likely these issues will eventually be resolved, this does raise short-term uncertainty.

Don’t hold your breath for big reforms

Tax reform would be highly welcome but equally unlikely. The Republicans are likely to only win a slim majority in the Senate, which would not be enough to prevent Democratic filibuster on more contentious proposals. A move to repeal the Affordable Care Act is also unlikely while the White House (and presidential veto) remains in Democrat hands.

Fiscal policy will add to GDP once again

No news is good news. Fiscal policy has turned positive and made a substantial contribution to GDP growth in Q3. A continuation of current spending patterns without any sharp cuts would be supportive of growth. One-off expirations of temporary tax cuts are also now behind us.

Republicans will control Congress in 2015-16

The latest projections indicate the Republicans will control the House and also the Senate.

Another major budget showdown is unlikely

The fear is that a Republican Congress would restart the bitter budget conflicts of recent years that led to sharp falls in consumer confidence and restrictive fiscal policies. Indeed, 2015 is not an election year and the risk of brinksmanship does rise. Recall the budget showdowns in 2011 and 2013, also non-election years.

But we believe another major budget showdown is unlikely. First, Republicans were disproportionately hurt relative to Democrats and the President during the 2013 government shutdown. It is likely the party will want to avoid a repeat of this episode, especially as we expect many Republicans want to appear to govern responsibly prior to the 2016 general election.

Note that some polling analysts expect the Democrats to re-take the Senate in 2016 since the Republican seats up for election will be the ones that President Obama won in the last general election.

2015 will be unlike 2011 or 2013. The large swing in their favour in 2010 had made Republicans believe in 2011 that an easy victory awaited them in 2012 – this was not the case. Furthermore, while the Affordable Care Act remains highly unpopular, the move to repeal it was not the winner that House Republicans thought it would be, as the 2013 shutdown revealed. These factors will reign in any potential brinkmanship and make a repeat of past budget conflicts unlikely.

Furthermore, hope is not lost when it comes to finding bipartisan support for passage of budget bills. The aptly named Bipartisan Budget Act of 2013 that lifted the sequester spending caps for two years passed with significant support from both parties. September’s Continuing Resolution that authorised Federal spending until the end of the year also passed with little debate.

But we believe another major budget showdown is unlikely. First, Republicans were disproportionately hurt relative to Democrats and the President during the 2013 government shutdown. It is likely the party will want to avoid a repeat of this episode, especially as we expect many Republicans want to appear to govern responsibly prior to the 2016 general election.

Note that some polling analysts expect the Democrats to re-take the Senate in 2016 since the Republican seats up for election will be the ones that President Obama won in the last general election.

2015 will be unlike 2011 or 2013. The large swing in their favour in 2010 had made Republicans believe in 2011 that an easy victory awaited them in 2012 – this was not the case. Furthermore, while the Affordable Care Act remains highly unpopular, the move to repeal it was not the winner that House Republicans thought it would be, as the 2013 shutdown revealed. These factors will reign in any potential brinkmanship and make a repeat of past budget conflicts unlikely.

Finally, the budget deficit has closed substantially as the economy has recovered. At 2.8% of GDP, this fiscal year’s deficit is the smallest since 2007 and is far smaller than it was in the 1980s. While this does not mean there is no need at all to resolve debt sustainability issues, there will be less political pressure to make sharp cuts. Indeed, given the sequester spending caps already in place, it would be tough to call for further austerity without hitting popular entitlement programmes or axing defence personnel, which is not an item on the Republican platform.

But uncertainty may still creep up

This does not mean all issues have been resolved. The September Continuing Resolution will run out by December by which time Congress will need to re-authorise Federal spending. Furthermore, the debt ceiling deadline is expected to be reached in March next year. Finally, the sequester spending caps likely have to be extended.

It is likely all these issues will be resolved on time with usual short-term ad hoc measures. For instance we will probably get another Continuing Resolution, a temporary extension of the debt ceiling, and a lift in spending caps for emergency defence-related reasons. But the fact we have to go through another round of legislating does raise uncertainty and may slightly unnerve markets prior to these issues being resolved.

Big reforms unlikely to come

The successful passage of some Republican proposals would be highly welcomed. For instance, the tax reform proposed by Ways and Means Chairman Camp would reduce the corporate tax rate to 25% and simplify individual income taxes.

Progress on this is highly unlikely. The Republican majority in the Senate will be short of the 60-seat “super-majority” necessary to avoid Democratic filibuster. The use of the filibuster to block legislation has increased rapidly in recent sessions of Congress. In any case the Democrats continue to hold the White House (and the presidential veto), making any large-scale Republican proposal of this sort, including a repeal of the Affordable Care Act, unlikely.

Don’t rock the boat – fiscal policy finally adding to growth

From a macro perspective, no news will be good news from the 2015-16 sitting of Congress. Fiscal drag has receded in recent quarters and government expenditures actually made a large contribution to growth in Q3. The outlook is fairly positive.

On the spending side, fiscal drag is expected to continue to recede as the path of Federal spending stabilises. We expect government spending to contribute around 0.1pp to the annual GDP growth rate in 2015.

On the tax side, distortionary expirations of temporary tax cuts are now behind us. In the past, the end of temporary tax cuts had sharply reduced household incomes and distorted consumption behaviour. We can look forward to no more of this kind of event in coming years.

What this means is that it would be good news even if we simply “stayed the course”. Households and firms would have certainty over future tax policies while government expenditure would take a stable course and contribute to overall growth. A session of Congress where Continuing Resolutions (or better yet, a full budget) were passed with no sharp cuts or distortionary temporary tax incentives would carry on the increasingly positive role fiscal policy plays in the US.

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