Taxing Times: What’s next after the Super Committee punted?

December 1, 2011 Categories: Economic Insights
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Paper balls

Congress has garnered a reputation for haggling until the last minute. But two days before its November 23rd deadline, the bipartisan budget Super Committee – which had been chartered in August with presenting Congress with a plan for cutting the deficit by $1.4 trillion over the next 10 years  – announced that it would fail to make a proposal of any type. The most pressing punishment for failure to arrive at a common proposal was automatic cuts to discretionary and defense spending starting in January 2013.

This ending for the Super Committee was disappointing. Hopes were high.

  • The proposal was granted the special status of an up-or-down vote (without amendments) in the full Congress.
  • The committee’s $1.4 trillion deficit reduction target was more ambitious than the $1.1 trillion automatic cuts.
  • There had even been talk that the committee might arrive at a grand bargain to include comprehensive tax reform above and beyond the group’s direct mandate. Such a grand bargain might have helped make even more of a dent in the $4 trillion long-term deficit reduction recommended by Standard & Poor’s.

However, after the fact, neither the Democratic nor the Republican side is in a position to play the blame game because neither side publicly put forth a concrete proposal that it could say was unreasonably rejected by the other side.

The anatomy of a failed agreement

Perhaps the fact that additional downgrade of U.S. Treasury debt was very unlikely regardless of the outcome of the Super Committee process, contributed to its failure.

  • The three largest ratings agencies had indicated that they would maintain the same credit rating based on the automatic cuts that were scheduled, with or without passage of a proposal from the Super Committee.1
  • This summer’s downgrade of U.S. Treasury debt by Standard & Poor’s was roundly ignored by the bond market – yields on 10-year Treasury bonds actually dropped after the downgrade, in a similar manner to what had happened to Japanese government bonds starting in 1999. In fact, it can be argued that a rating agency downgrade on sovereign debt issued in the sovereign’s own currency amounts to nothing more than a strong suggestion that bond investors think long and hard about charging a higher inflation risk premium on all debt issued in that currency. The government could always keep current on its debt repayment simply by printing money – and so inflation (not outright default) would be the real risk. The bond market shrug suggested that the ratings agency would likely not be eager to press ahead with any further rating downgrade.

What about those automatic cuts

In addition to the automatic cuts in defense and discretionary spending, the Super Committee’s failure also casts doubt on further extension of unemployment benefits and the 2% temporary cut in payroll (Social Security) taxes. These extensions are currently slated to expire at the end of 2011 and had been widely expected to continue in 2012 as part of a Super Committee grand bargain.

Economists at JP Morgan Chase & Co. estimate that failure to renew these two programs could lower U.S. economic growth by a combined 0.8% in 2012.2 The Congressional Budget Office estimates that aid to the unemployed and payroll tax reductions are the two policies that have the greatest impact on GDP per dollar of budgetary cost.3

Is the base-closure commission the future of budget consolidation?

In the aftermath of the Super Committee’s failure, some observers are calling on President Obama to embrace the December 2010 recommendations of the external, bipartisan Fiscal Deficit Committee (aka Simpson-Bowles Commission), nominated by the President to provide guidance on long-term budget consolidation.

In terms of process, the up-or-down vote the Super Committee’s proposal was going to enjoy is reminiscent of the set-up of the base-closure commission. Between 1989 and 2005 that commission successfully used the up-or-down vote process five times to close a number of Defense Department bases.4 The process facilitated the difficult task of individual members of Congress proposing base closings in their, or their colleagues’, districts by turning over the proposal responsibility to an external committee whose members were appointed by the President and confirmed by the Senate.5 Congress was then presented with a full slate of proposed base closings that is subject to an up-or-down vote with no amendments.

Given the Super Committee’s failure even to submit a plan for a vote, it is possible that the future of budget consolidation in the United States lies with an external committee akin to the base closure commission.  This would amount to giving a group like the Simpson-Bowles commission the privilege of preparing a slate of budget-consolidation steps for an up-or-down vote. This might sound like outsourcing the tough decisions, but it was necessary for base closings and might be necessary for budget consolidation also.  Nevertheless, the full Congress must still approve the overall package, and the president must sign the bill for final passage.

Abraham Robison, an investment strategy analyst for Russell Investments, contributed to this post.

1 Fitch reaffirms U.S. AAA credit rating, but outlook now negative“, by Jim Puzzanghera, Los Angeles Times, November 28, 2011.

2 Supercommittee failure threatens recovery as rating affirmed“, by Heidi Przybyla, Bloomberg Businessweek, November 29, 2011.

3 Policies for increasing economic growth and employment in 2010 and 2011“, by Congressional Budget Office, The Congress of the United States, January 2010.

4 United States Department of Defense, Base realignment and closure 2005: http://www.defense.gov/brac/

5 United States Department of Defense, Defense base closure and realignment act of 1990 (amended through FY 2005): http://www.brac.gov/docs/BRAC05Legislation.pdf

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