What Budget Deal?

This morning, some top Wall Street investors called around to check on whether a big budget deal might emerge from the “Gang of Six” talks after the Wall Street Journal published this article, claiming “tentative backing of 31 senators: 16 Republicans and 15 Democrats.” Woaa! Wait a minute!

Before you start buying long Treasuries, read further down:

“Lawmakers appear split over how quickly to propose the package. Some believe they could try and attach it to a coming vote in a few weeks on whether to raise the government’s borrowing limit above $14.3 trillion. But Messrs. Chambliss and Warner have said they don’t know if their effort will be completed in time.”

Once the debt limit is raised for the rest of the year, this year’s budget battles will be over. “Tentative backing” and 50 cents used to get you a cup of coffee. Sure there have plenty of discussions about doing something big to bring down the deficit. Doing it is a lot more difficult. A big budget deal would occur only if a long-term debt limit increase and government funding deal were part of it and only with strong presidential leadership.

When I talk to congressional staff about this, in order of frequency, I hear:

  1. President Obama is on the sidelines.
  2. Democrats won’t touch Social Security.
  3. Republicans won’t raise taxes.
  4. Republicans will doggedly pursue further non-security discretionary spending cuts.

Everyone agrees no one knows how this will end. The 2012 election campaign is well underway. President Obama’s weekly “Win the Future” visits around the country are also raising large amounts of campaign finance. Members of Congress in both parties are terrified of facing the voters. Incumbents are more vulnerable than any time in recent memory. Republican incumbents face Tea Party challengers, and Democrats are under attack from the liberal and conservative wings of their party. What would you do if you prime objective was to win the next election? You would promise a lot and do as little as possible that might offend anyone. You certainly wouldn’t cut benefits or raise taxes. You’d only vote for a big deficit reduction package if you were sure that your political opponents were voting for it too and that your party leaders would staunchly defend you and fund you in the 2012 election.

Nonetheless, the article says:

“Republicans have agreed to consider raising new revenue through the tax code—without raising tax rates—and Democrats have agreed to trim Medicare benefits, moves that would be major concessions from both parties.”

That may be true of the “Gang of Six” or of all 31 senators, but will they hold together when their leadership balks, when President Obama looks the other way, and when protesters start camping out around the Capitol like that have until recently in the statehouse in Madison, Wisconsin? Besides, nothing is going to pass the Senate with less than 60 votes, so we’re only halfway there even if the 31 senators hold together.

Let’s get real here. A more likely scenario would be:

The next CR, for one month, includes more non-security discretionary spending cuts, but less than the $4 billion per two weeks of the first one.

After a short-term debt limit increase or two, a debt limit increase until early 2013 passes with discretionary spending caps for the next three to five years to ratchet spending down in the mid-range between FY08 and current levels in real terms.

Medicaid might be capped, but no cuts to Medicare or Social Security, and no tax increases.

In my opinion, we’re seeing the first baby steps towards significant long-term deficit reduction. It took 17 years from the first spending cuts in 1981 to reach budget balance in 1998 after a peak deficit of 6% of GDP. This time, starting from a peak deficit of 10% of GDP, restoring budget balance will take longer.

About Pete Davis 99 Articles

Affiliation: Davis Capital Investment Ideas

Pete Davis advises Wall Street money managers on Washington policy developments that affect the financial markets. President of his own consulting firm since 1992, Davis Capital Investment Ideas, he draws on 11 years of experience as a Capitol Hill economist with the Joint Committee on Taxation (1974-1981), the Senate Budget Committee (1981-1983), and Senator Robert C. Byrd (1992). He worked in the House and Senate, and for Republicans and Democrats.

Davis brought the first computer policy model, the Treasury Individual Income Tax Model, to Capitol Hill in early 1974, when he became a revenue estimator on the Joint Committee on Taxation. He formulated the 1975 rebate, the earned income tax credit, the 1976 estate tax rates, the 1978 marginal tax rates, and the Roth-Kemp tax cut. He left Capitol Hill in 1983 for the Washington Research Office of Prudential-Bache Securities, where he advised investors for seven years.

Davis has long written a newsletter on the Washington-Wall Street connection for his clients; Capital Gains and Games is his first foray into the blogosphere.

Visit: Capital Gains and Games

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