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March 01, 2024 | 13:33
U.S. Fiscal Update: Kicking the Can... Again
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U.S. Fiscal Update: Kicking the Can... AgainU.S. lawmakers gave themselves more time to hammer out a full budget, passing another continuing resolution (CR) this week to keep government agencies funded at their current levels and thus avoiding shutdowns. This is the fourth CR since the last fiscal year ended September 30. There is already an agreement (part of the third CR that was enacted on January 19) to hold total non-discretionary spending at $1.66 trln, not including any supplemental funding. However, among the latter, funding for Ukraine, Israel, and border security have been stumbling blocks for the whole budget process. |
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The $1.66 trln is being allocated across 12 appropriation bills, of which there is already agreement on six. Final text and other technical matters must still be completed, and the CR calls for the six-bill package to be enacted by March 8. The remaining six bills (which include Defense and Homeland Security) must be enacted by March 22. As has become the custom, if these deadlines aren’t met, government shutdowns would occur... unless there’s a fifth CR. Political partisanship and brinkmanship are again making the fiscal process dysfunctional, as was the case last summer in lifting the debt limit. And it’s not just Democrats (who control the Senate) battling Republicans (who control the House). It’s also within the GOP as the extreme fiscal hawks clash with their more mainstream colleagues. With elections looming this November, we suspect the dysfunction will become more pronounced. Taking stockThe Congressional Budget Office (CBO) released its latest 10-year ‘baseline’ budget projections last month, based on legislation enacted as of January 3. Note that although this was before the January CR, both sets of discretionary spending figures reflect the caps imposed by the Fiscal Responsibility Act, which was enacted last year in raising the debt ceiling. |
For the current fiscal year, the deficit is projected to be $1.51 trln or 5.3% of GDP (Chart 1), an improvement from $1.70 trln (6.3%) in FY2023 that, in turn, represented a deterioration from $1.38 trln (5.4%) in FY2022. The latter was the low-water mark after back-to-back budget shortfalls were ballooned by pandemic relief measures (e.g., 2020 topped $3 trln or 14% of GDP). However, this year’s improvement partly reflects a rebound in revenues caused by one-time factors that dampened revenues last year (and contributed to the deficit’s deterioration). For example, the IRS delayed the 2022 tax filing deadline in California until November because of extreme winter weather, pushing tax payments into FY2024 instead of 2023. And, although the pandemic’s Employee Retention Tax Credit ended in 2021, there was a surge in refunds during FY2023 as businesses submitted amended returns. |
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As revenues normalize next year (FY2025) amid continued spending growth, the deficit hits $1.77 trln or 6.1% of GDP. We reckon this would be close to a (starting) run rate if not for the scheduled sunset of the personal income and estate tax reductions from 2017’s Tax Cuts and Jobs Act (TCJA). Those measures are expected to expire at the end of calendar year 2025. Into the sunsetUnder congressional budget rules, tax cuts that raise the cumulative 10-year deficit must be offset by tax increases elsewhere. With the TCJA’s corporate tax cuts made permanent, this meant the Act’s personal tax cuts had to be reversed beginning in 2026 to pay for the permanency (on paper). The legislation’s authors judged that it would be politically unpalatable to raise personal taxes in the future, potentially making those tax reductions permanent too. It these personal tax cuts were extended indefinitely, they would cost over $3.3 trln by 2033, according to the Committee for a Responsible Federal Budget. This is Donald Trump’s position with some Republicans even arguing to expand them. President Biden said he would make them permanent for households making under $400,000 annually. But he would pay for this, and net an additional $2 trln, by augmenting the implied tax increases for the above-$400k crowd along with higher taxes on corporations (both undisclosed). The CBO’s current 10-year deficit tally is at $20 trln and includes complete sunset. Whether the figure ends up topping $23 trln, or coming in closer to $18 trln, debt—and the interest payments on it—will still be mounting meaningfully. Interest climbs debt mountain |
The CBO’s latest baseline forecast shows gross federal debt held by the public, as a percent of GDP, rising from 97.3% last fiscal year to 99.0% this year and 101.7% next year (Chart 2). The ratio hits a record of 106.3% in 2027, surpassing the previous high of 106.1% hit in 1946, in the aftermath of WWII. Even if interest rates don’t rise, growing debt results in increasing interest payments—but rates are rising. In January, the average interest rate on marketable Treasury debt was 3.21%, nudging above the 3.20% mark for the first time since December 2008. With the entire Treasury yield curve hovering well above this level, the average interest rate is going to keep increasing as debt is refinanced (with its average maturity of 71 months). Net interest is projected at $870 bln (3.1% of GDP) for this fiscal year, up from $659 bln (2.4%) last year (Chart 3). Already hovering at record highs in dollar terms since FY2022, it’s poised to top $1 trln in 2026, which would also set a record as a percent of GDP at 3.3%. To put this in perspective: this year, interest payments will top defense spending as an outlay. Next year, they will also surpass non-defense discretionary spending. In the CBO baseline, it’s the steady rise in net interest along with growing mandatory outlays (think an aging population) that pushes the deficit ratio back up to the mid-5% range despite the sunset of personal tax cuts. In the final few years of the projection period (2032-34), the deficit ratio leaps back above 6%. The culprits are the insolvencies of the Medicare Hospital Insurance (Part A) Trust Fund in FY2031 and the Social Security Old-Age and Survivors Insurance (OASI) Trust Fund in 2033. When these trust funds become insolvent (meaning current and accumulated surplus contributions no longer cover benefit payments), the residual funding of these mandatory outlays shifts back ‘on-budget’. That adds directly to the deficit. Biden timeIt’s interesting to compare the CBO’s latest budget projections to those that were done three years ago, as the Biden Administration and Democrat-controlled Congress (at the time) were starting their jobs (Chart 4). Their Build Back Better agenda unfolded with the American Rescue Plan Act, the bipartisan Infrastructure Investment and Jobs Act, and the Inflation Reduction Act. Looking at the overlapping 2021-to-2031 period, the cumulative deficit is now $5.5 trln larger than at the start. Revenues are $7.0 trln higher. However, total discretionary spending is up ‘only’ $1.2 trln amid higher mandatory spending ($5.9 trln) and net interest ($5.4 trln). The latter two items can be awfully constraining. |
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Bottom LineThe CBO has long warned that rising debt and interest payments were going to increasingly constrain fiscal policy flexibility. But controlling deficits to stabilize the debt-to-GDP ratio is a can that governments of both political stripes have continued to kick down the road (pandemics and global financial crises aside). Meanwhile, the budgetary consequences of Medicare and Social Security trust fund insolvency have always lurked on the long-term horizon, making them an easy can to kick as well. But these are fast becoming a medium-term phenomenon and another increasing constraint on policy flexibility over the next 5-to-10 years. This November, whoever wins the White House and whichever party wins control of Congress (if one is able to do so), they might find that their can-kicking days are coming to an end. |