Look Beyond the U.S. Budget Bluster

The Republican-controlled House and the Democrat-controlled Senate have each produced budget proposals for 2014 and beyond. Even though President Obama's effort has yet to arrive on stage, the theatrics have begun. Each side has accused the other of accounting gimmicks, of ignoring the will of the American people, of favoring one group in society unfairly over another. Inevitably, there are the accusations from each side that the other's "math" does not work and so its promises will inevitably disappoint. The irony, in my opinion, is that both sides are right. With no disrespect to either Representative Paul Ryan (R-KY) or Senator Patty Murray (D-WA), who have both presented budget proposals, such a judgment simply has good grounding in Washington's fiscal history: Republicans and Democrats have always overpromised.

Amid all the theatrics, each group also claims that there is no room for compromise. The other's proposals, they say in one way or another, are simply too obnoxious even to consider. This, too, is a familiar pattern. And there is no denying that much of what either group proposes will likely ever get the votes of the opposition. But at the same time, these two proposals—dissimilar as they appear on the surface—incorporate many similar principles of fiscal reform—a common thread that offers more chance of compromise than it would seem at first or that has existed for some time. Agreements likely will take time and probably will not occur this year. Much depends on whether the president's budget takes advantage of these commonalities. But in all the despairing budget commentary these days, investors, businesspeople, and citizens need to recognize this positive potential.

This commonality emerges in three fundamental areas: 1) a recognition that the growth of federal spending must slow, certainly compared with the recent past; 2) a desire to simplify the tax code by reducing statutory rates and eliminating deductions and credits; and 3) an inclination to use government support for insurance as a way to achieve health care for all citizens. Such directions, however, are not new. They have emerged again and again in fiscal debate. Paul Ryan, for example, has included them in earlier budget proposals. Budget-reform efforts from both sides of the aisle in the Senate have included them. They were evident in the proposals of both the Domenici-Rivlin and the Bowles-Simpson commissions.1Elements, admittedly in vague and oblique forms, have appeared in President Obama's remarks, most notably in the corporate tax reform proposals he included in his 2012 State of the Union address.

On the first of these, the spending cuts, Ryan is clearly more forceful than is Murray. He would use various means to cut $4.6 trillion cumulatively from the federal spending stream over the 10 years to 2023.2Murray promises only $1.0 trillion less spending.3Ryan would commit the bulk of his cutting to repeal the Patient Protection and Affordable Care Act. But in areas more palatable to Democrats, Ryan would also look for cuts in defense spending, certainly relative to its trajectory of recent years, and non-defense discretionary spending as well. He would reduce each relatively, from 4% of the economy today to 2.5% and 3.0%, respectively. Though the figures and the emphasis are different, Murray would essentially go in the same direction. She would, nevertheless, spare the Affordable Care Act, but her proposals still look for $275 billion in cuts to Medicare and Medicaid, almost a third of her total savings.4She also would cut defense and non-defense discretionary spending. Great as the differences in detail are, these common efforts at cuts still open a door to compromise, one that did not exist in past years.

If anything, the common direction on tax reform appears even more evident. Murray looks to reform to raise revenue, while Ryan insists on revenue neutrality, but both in common want to reduce statutory rates and simplify the code by eliminating or curtailing the use of deductions and credits. Ryan, consistent with his past proposals, would have only two individual tax brackets, at 10% and 25%.5Murray has stopped short of such specifics. Her proposals merely instruct the Senate's tax writers to find the additional revenue, but she aims to reduce rates. Neither Ryan nor Murray indicate which deductions and credits they would eliminate or curtail, but since both would clearly move away from the current code in similar ways, here, too, negotiators would seem to have space for compromise.

The House and Senate proposals on entitlements reform seem diametrically opposed, and there are major differences. After all, Ryan wants to repeal the Affordable Care Act, something Murray is determined to protect. Ryan would fund Medicaid with block grants to the states, leaving the details of implementation to governors and state houses, whereas Murray's proposals would follow the healthcare legislation and extend Medicaid as a part of the new law. But if such differences seem huge—and they are—there also is much that is similar. Ryan's plans for Medicare, after all, look very much like aspects of the Affordable Care legislation. Both plans, in different ways, would offer premium subsidies to help people purchase individual health insurance. Of course, Ryan would dispense with the individual mandate, but, ironically, his plan for Medicare includes a government-run insurance option that Affordable Care Act lacks.

Some of the gaps are so wide that compromise will take tremendous effort. But these similarities nonetheless offer groundwork for specific gives and takes that previously have not existed. It is too early to tell, though, whether Washington will capitalize on this new opportunity. The president's budget, when it finally appears (since it is more than two months late), will indicate how interested he is in building on such a base. He can accelerate the process or force the government and the country to wait. Given past patterns, chances are that the wait will extend until after the 2014 midterm elections, when Washington will get a feel for where the electorate wants to go. But even in the face of such a frustrating prospect, matters now, contrary to all the apocalyptic commentary, offer greater opportunity than in a long while and should allow Washington to finally give markets and the economy some pleasant news for a change.

1 Respectively, former Senate Budget Committee chairman Pete Domenici (R-NM) and former White House budget director and Federal Reserve vice chair Alice Rivlin, and Erskine Bowles and former senator Alan Simpson (R-WY).

2 All data on House of Representative proposal from the House of Representative website.

3 All data on Senate proposal from the Senate website.

4 Ibid.

5 Ibid.

The opinions in the preceding commentary are as of the date of publication and subject to change based on subsequent developments and may not reflect the views of the firm as a whole. This material is not intended to be legal or tax advice and is not to be relied upon as a forecast, or research or investment advice regarding a particular investment or the markets in general, nor is it intended to predict or depict performance of any investment. Investors should not assume that investments in the securities and/or sectors described were or will be profitable. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy or completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.

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