Congress Avoids a Government Shutdown; Up Next, the Debt Limit
Congress cleared another hurdle last week, passing a bill (a “continuing resolution”) to keep the federal government operating for six months past its current funding deadline of March 27.
The continuing resolution also eliminates some of the draconian effects of the “sequestration” spending cuts that began on March 1. The real unhappiness with the cuts lies in the way the sequestration process operates. Sequestration imposes an across-the-board ratable reduction in spending that does not stop at the agency level. Rather, it goes down to departments within each agency and to spending accounts within those departments. Thus, the process robs agency heads of the ability to reallocate funds within their agencies to retain full funding for crucial programs. For instance, the Secretary of Defense cannot allocate funds from non-essential defense functions to keep the armed forces operating at current levels.
The continuing resolution funds the government at existing spending levels (maintaining the sequester cuts). But it ameliorates some of the adverse effects of sequestration by giving the Secretary of Defense the ability to reallocate funds within his department, and by prescribing reallocations to crucial functions within some of the other the federal agencies.
Now we turn to the next fiscal deadline looming in 2013. On May 18 the United States will hit its borrowing limit. After that date, the government will be able to continue to pay expenses for another few months without additional borrowing. But around July or August the limit will have to be raised or the United States, unable to borrow, will be unable to meet its existing obligations, including paying interest on outstanding debt.
In the past week, each house of Congress has passed a proposed budget. This alone is an improvement over recent practice -- Congress has not passed a budget to run the federal government in four years. This year, we have a plethora of budgets – one each from the House, the Senate, and the President. It will not be politically feasible to meld the disparate proposals into a single budget. But those budgets will become blueprints for negotiations -- negotiations that will crest around August when the debt ceiling must again be raised.
The difference in the two budget proposals is stark. Indeed, they are virtual mirror images of each other, opposite in almost every regard. The Republican plan, drafted by Rep Paul Ryan and passed by the House:
- Balances the budget over ten years through spending cuts alone
- Contains no new tax revenues
- Increases projected defense spending
- Changes Medicare to a “voucher” system, which allows recipients to choose among private and public plans and provides premium subsidies based on income
- Turns Medicaid into a block grant to the states and caps the growth in federal expenditure
- Repeals health care reform (but keep the methods for financing it)
The Democratic plan, drafted by Senator Patty Murray and passed by the Senate:
- Does not purport to balance the budget in the near or intermediate term
- Calls for a dollar of new tax revenue for every dollar of spending cuts
- Creates new spending initiatives for infrastructure repairs and job training
- Cuts defense spending
- Makes no changes to entitlements (Social Security and Medicare)
In an effort to pave the way for a smoother debt ceiling negotiation, the President recently undertook a “charm offensive,” inviting Republican Senators to dinner and meeting separately with the Congressional party caucuses. In those meetings, he emphasized his desire for a “grand bargain” to fix the deficit. But the differences between the parties aren’t limited to niceties; they are deep and defining. At the end of the day, the Democrats want additional taxes and the House Republicans – believing Obama got his new tax revenue in the fiscal cliff compromise – are dead set against them. Entitlements are almost an equally strong divide. Republicans assert that the only path to fiscal responsibility is to reform Social Security and Medicare. House Democrats, at least in their public statements, have adamantly refused to consider them (although the President is more open to some entitlement changes).
So, the President’s efforts notwithstanding, negotiations over the spring and summer are likely to follow the tortious path we’ve seen repeatedly in past years. The initial positions don’t portend a quick compromise. On the one hand, the Ryan budget calls for repeal of health care reform, sure to anger Democrats who believe that issue is settled. On the other, former House Speaker Nancy Pelosi recently asserted that “it is almost a false argument to say that we have a spending problem” at all. Failing to recognize the need to cut any spending will not sit well with Republicans.
This is not to say that a deal won’t get done, only that it will not be easy or early. My guess is that the debt limit will be the “forcing event” that compels compromise at close to the last minute. It will be a repeat of August 2011 – the last time the country engaged in the debt limit debate.
In the meantime, the rhetoric – fueled by a flurry of media reports – could hinder the equity markets. They might pull back a bit from their run-up, much as markets fell in August 2011 during what was otherwise a strong year. To the extent a correction is based on a perception that Washington will be unable to reach agreement, I believe that concern will be misplaced. The United States is not going to default on its debt. Thus, any correction based on Washington dysfunction should be temporary, reversing when a compromise is reached. This is not to suggest that investors should sell equities in anticipation of a correction, because they will not know when a compromise is imminent so they can buy back in. But a market correction based on the perception of Washington dysfunction could be a buying opportunity.
A similar analysis applies to the municipal bond market. Municipal bond values have pulled back recently, in part due to a proposal by the President to tax a portion of municipal bond interest received by affluent investors. In my view, Congress is unlikely to adopt that proposal. When it becomes apparent the proposal is legislatively dead, the municipal bond market may rally. The tax-exemption provided by municipal bonds is more valuable than ever, now that the top tax rate has increased almost ten percentage points due to the fiscal cliff compromise. Again, a correction in the muni bond market could be viewed as a buying opportunity.
Neither the author of this paper, nor any law firm with which the author may be associated, is providing legal or tax advice as to the matters discussed herein. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. It is not intended as legal or tax advice and individuals may not rely upon it (including for purposes of avoiding tax penalties imposed by the IRS or state and local tax authorities). Individuals should consult their own legal and tax counsel as to matters discussed herein and before entering into any estate planning, trust, investment, retirement, or insurance arrangement.
Copyright Andrew H. Friedman 2013. Reprinted by permission. All rights reserved.
