Economics and Politics Affect Budget Outlook

The economy, which consistently tops polls as Americans’ chief concern, is sending mixed signals to Washington. While Washington can be an insular place, its actions are heavily influenced by economic and related events that dominate media and public attention. Policy decisions on the federal budget, appropriations, and agency spending can be driven by economic news.

At the end of January, the federal government’s debt broke the $30 trillion mark, $30,012,386,059,238.29 to be precise. The government recently reported that inflation rose to 7.5%, the largest increase since 1982.

But the economy has bounced back from the pandemic much faster than most projected and is showing remarkable strength despite headwinds. The January jobs report showed an employment gain of 467,000 jobs, just as the Omicron variant was peaking. Unemployment has been a persistent problem in the past, but this time around the problem is the lack of workers, not jobs.

America’s job machine is going stronger than ever, fueling a strong recovery and opportunity for hardworking women and men all across this great country.

President Biden,
February 4, on the January jobs report

Despite the good employment news, President Biden’s approval rating has dropped to close to 41%. Rising prices, a growing federal debt, and fatigue from COVID disruptions headline the list of public concerns nine months before mid-term elections that could change control of the House and Senate.

SHORT AND LONG-TERM OUTLOOK FOR THE FEDERAL BUDGET

With a 50-50 Senate and a four-vote margin in the House, there is a lot of uncertainty about the next steps on the budget. An exception is that prospects for a government shutdown before the November elections have fallen below 5% as evidenced by House and Senate approval of a third continuing resolution (CR) with bipartisan support. Next up on the budget front are the full FY22 appropriations bills and possible action on a scaled back Build Back Better bill.

Senator Manchin has indicated support for a dramatically scaled-back Build Back Better bill, and bicameral, bipartisan Appropriations Committee leaders reached an agreement on a discretionary spending (agency annual operating and program budgets) topline and framework to pave the way to complete FY22 appropriations.

GROWING RESISTANCE TO DEFICIT FINANCED LEGISLATION?

The harder call is the course the federal budget and appropriations will take after this year. Since the pandemic, Congress has approved six major pieces of legislation that deficit-financed roughly $6 trillion to address the national emergency. With divided government, five of the six enjoyed strong bipartisan support. Partisanship reasserted itself in 2021. By using the budget reconciliation process, Democrats managed to enact the last COVID bill, the American Rescue Plan Act, despite unified Republican opposition due its cost and deficit impact. Congressional Republicans also are united in their opposition to the Build Back Better reconciliation legislation. Senator Manchin’s opposition has sidelined the House-passed bill.

I cannot take that risk with a staggering debt of more than $29 trillion and inflation taxes that are real and harmful to every hard-working American at the gasoline pumps, grocery stores and utility bills with no end in sight.

Senator Manchin (D-WV),
December 19, on the Build Back Better Act

Congress, however, has not given up on passing legislation that is deficit financed. While the proponents of the bipartisan infrastructure bill asserted that it was fully offset, the Congressional Budget Office (CBO) concluded it would increase the deficit by $256 billion over ten years. Congress is considering an international competitiveness bill that CBO estimates will increase the deficit by $53.5 billion over 10 years. Negotiations on an FY22 appropriations topline, like recent budget agreements, are likely to produce spending levels that increase the deficit relative to CBO’s baseline.

In addition to inflation’s recent spike, interest rates are on the rise. Markets have reacted to both higher inflation and the Federal Reserve signaling a rate increase in March, with the interest rate on 10-year Treasury securities hitting the 2% mark on February 10, the first time since 2019. To the extent inflation persists and interest rates continue to rise, American pocketbooks will be hit, which will likely lead to greater concern over Federal spending and deficits. Further, rising inflation and interest rates will consume a greater portion of the federal budget (see Washington’s Struggles with Inflation from our November report).

The difficult question is how Congress will respond. When either party gains complete control of government (White House, Senate, and the House), they usually move aggressively on partisan agendas. This has increasingly come at a cost of higher deficits and debt. House Republicans seem poised to break Democrats’ current control of government and retake the majority in this year’s mid-term election. If that happens and if history is a guide for the future, then looking back at what happened after Republicans took the House in 2010 is instructive.

THE 2011 TURN IN THE FEDERAL BUDGET

With President Obama’s election in 2008, Democrats took control of the government with large majorities in the House and Senate. They quickly moved to enact a partisan legislative agenda. Based on CBO data, in 2009 and 2010 Congress enacted legislation that increased the deficit by a total of $4 trillion for FY09-FY20. In 2011, during the first eight months of Republican control of the House, Congress enacted legislation that reduced the deficit by $2.3 trillion, according to CBO. Republicans forced budget cuts by using the debt limit as leverage to enact the Budget Control Act (BCA) with spending caps enforced through sequester.

A repeat of the 2011 experience seems unlikely. Since then, the debt limit has been temporarily suspended in bipartisan budget agreements and is less likely to be used for leverage. Most recently, while Republicans insisted on spending reductions as part of the most recent debt limit increase, the Biden Administration and congressional Democrats did not go along. A December agreement between Senate Majority Leader Schumer (D-NY) and Republican Leader McConnell (R-KY) resolved the impasse by allowing the debt limit to increase by a simple majority vote – 50 Democrats in favor to 49 Republicans against. In addition, the Appropriations and Armed Services Committee are unlikely to support deep reductions in discretionary spending for agency operations and annually funded programs.

[P]olicymakers should avoid presenting the idea that supply improvements will magically bring down inflation as anything more than a highly optimistic scenario.

Former Treasury Secretary Summers,
February 3, via the Washington Post

Even so, concerns about the economy and rising debt will continue to hold policymakers’ attention. Congress has the most control over discretionary appropriations and typically looks there first to control spending. Spending restraint is likely to grow if recent inflation and interest rate increases persist, increasing pressure on agency budgets over the next 18 months.