Morgan Stanley Investment Management's Andrew Harmstone on the likelihood of another Democrat/Republican showdown when US budget negotiations recommence early next year.
Policymakers have known for a long time that the ageing US population would raise the cost of financing major entitlement programmes, such as social security, and could lead to funding shortfalls. The 1994-1996 Advisory Council on Social Security Report stated: “Because of the ageing US population… the simple passage of time will put the [social security] system into deficit.”
The problem has been growing inexorably to the point that the Congressional Budget Office (CBO) estimates that, if there are no changes in current law, by 2038, spending on social security and major healthcare programmes will account for 72% of the total federal government revenue, up from an average of 40% from 1973 to 2012.
In 2010, President Obama was sufficiently concerned that he appointed the bi-partisan Simpson-Bowles Commission to investigate this problem. Its goal was to propose recommendations that would, by 2015, “meaningfully improve the long-run fiscal outlook, including changes to address the growth of entitlement spending and the gap between the projected revenues and expenditures of the federal government”.
Is the US headline for another government shutdown?
The Commission issued its report – entitled The Moment of Truth – in December 2010. Its recommendations were to cut discretionary spending, reform and contain the costs of entitlement programmes, as well as implement comprehensive tax reform.
Although Simpson-Bowles was structured to be bi-partisan and was appointed by a Democratic president, its recommendations resonated more with the Republican Party than the Democratic Party.
The latter does not appear to have bought into the need to curb the growth in entitlement programmes. In fact, these programmes, which now include the Affordable Care Act (‘Obamacare’), are among its proudest achievements.
Without meaningful Democratic Party support and ownership of the painful reforms Simpson-Bowles recommends, the debate on the US budget and debt limit has become highly partisan. Democrats resolutely fight off attempts to cut back on entitlement programmes, while Republicans aim to force cutbacks by using their control of the House of Representatives.
There have been acrimonious ‘showdowns’ on deficit and debt reduction since the Simpson-Bowles report. In August 2011, it looked as if the US government might be forced into a technical default due a refusal of the Republican-controlled House to raise the debt ceiling– until the very last minute.
In this instance, the quid pro quo was the Budget Control Act of 2011. Among other things, this Act imposed ‘sequestration’ that has resulted in across-the-board government spending on non-entitlement programmes since March 2013. It also set the stage for repeated difficult negotiations because of its indiscriminant impact and lack of flexibility.
Moreover, it does not address the core long-term issue of curbing the growth of entitlement programmes to sustainable long-term levels.
Unfortunately, this issue will not go away if the CBO debt and deficit projections are accurate.
This means highly disruptive budget negotiations will become the norm. The latest showdown, ending on 16 October this year, pushed the US government to the brink of a technical default and caused a 16-day partial shutdown of the federal government that furloughed 850,000 employees.
Good news from this showdown is that serious negotiations are now taking place between the Democrat-controlled Senate and the Republican-controlled House of Representatives.
Nonetheless, progress to date appears limited. Unfortunately, deadlines for compromise loom. An agreement on the US federal budget is due by 15 January 2014 or there is the risk of another shutdown. The government authority to borrow will again be limited after 7 February 2014. Unless there is an agreement to extend the limit, there is, again, a threat of technical default.
The political and economic damage to both parties from the October showdown suggests a compromise in early 2014 is likely, especially to modify arbitrary sequester-linked budget cuts. It is less clear, however, that the key issue of making entitlement programmes sustainable in the long term will be resolved. Until it is, investors may need to prepare for continuing showdowns.
Reasons to be cheerful
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