Macro update (reconciliation (tax/spending legislation), FY25 gov’t funding, debt limit)

Recent/upcoming developments… It appears House Republicans are within a week of taking their first formal legislative step on their “reconciliation” bill, which will include extensions of expiring provisions of the Tax Cuts and Jobs Act (TCJA), possibly other tax cuts, defense/border security funding, and various spending reductions.  Their plan is to hold a House Budget Committee vote on their “budget resolution” the week of 2/3.  The budget resolution specifies how much the reconciliation bill will increase or decrease the deficit, and it may also be used to specify the baseline against which the Congressional Budget Office (CBO) measures the deficit impact.  House Republicans are contemplating requiring that the bill reduce the deficit by ~$2.5t.  While the budget resolution does not specify the specific tax cuts and spending reductions that will achieve the required deficit impact, Republicans are actively considering those specific provisions, with committee chairs having met this week to begin discussion ideas with the party leadership.  Senate Republicans appear to be on a slower timeline and there’s no indication they’ve reached agreement on the approach being developed by House Republicans.  Meanwhile, the bipartisan leadership of the House/Senate Appropriations Committees have begun to negotiate over the topline spending targets for the legislation they need to pass by 3/14 that will provide appropriations (funding for government operations, grants, etc.) for the remainder of FY25.  They are apparently considering allowing both defense and non-defense spending to grow by 1% for FY25.  House Republican leaders are considering adding the debt limit, disaster funding, and border security funding to the March appropriations bill.

* The menu of options for reducing spending/increasing revenue in the reconciliation bill that was circulated by the House Budget Committee last week appears intended to be illustrative and does not reflect political receptivity to the various options.  However, the following more refined (but still incomplete) set of options emerged this week, which are likely more politically viable, given that they were proposed more specifically by House committee chairs.  While not fully resolved, this list represents those policy options that appear to be gaining more momentum than others.

– Medicaid work requirements

– Medicare site neutral payments

– Limits on student lending and termination of Biden-era student loan debt forgiveness

– Work requirements for food stamps (SNAP), welfare (TANF)

– Claw-backs of IRA clean energy spending and constraints on IRA clean energy tax credits

– Increase in federal employee contributions to retirement benefits

– Shifting funding for the CFPB from Fed’s budget to annual appropriations

– Expanded oil/gas, mining leases

– Fees on immigrations (e.g., asylum applications, parole)

– Transportation fees (e.g., tonnage duties on ships, EV fees)

* There are a number of other options for reducing spending/increasing revenue that have been visibly mentioned in the last few weeks, but were not reflected in reports about deliberations among House committee chairs this week.  Among others, this includes a mandate that the FCC conduct spectrum auctions, which has been mentioned by numerous key players on telecom policy (e.g., House Energy and Commerce Committee Chair Guthrie (R-KY), but has encountered push-back from others (e.g., Sen. Rounds (R-KS)), as well as a requirement that the GSEs exit conservatorship, which House Financial Services Committee Chair Hill (R-AR) has previously highlighted, but today appeared to defer to the Trump team, which has thus far not signaled the issue is a priority.

Our outlook… In preparation for House Budget Committee passage of the budget resolution, it’s our expectation that we’ll begin seeing decisions next week on where House Republicans set the deficit target for their reconciliation bill.  It’s also possible that the House budget resolution will specify that CBO should “score” (evaluate) the bill’s deficit implications on a “current policy basis” (i.e., with no revenue impact from extending TCJA), though they may wait to do so until later in the process since it’s ultimately up to the Senate Parliamentarian and Budget Committee Chair to address budget enforcement questions.  Our current expectation is that the bill will require ~$1t in deficit reduction vs. a current policy baseline.  Separately, we expect Appropriations Committee leaders to agree to a 1% increase in discretionary spending for FY25 next week, and that negotiations over the debt limit, disaster funding, and other issues associated with the appropriations bill will continue into March.  Our view is that there’s a 65% probability that multi-year debt limit increase will be included in the March appropriations bill.  House Minority Leader Jeffries (D-NY) has objected to this approach, but Democrats are ultimately likely to be attracted to supporting it in exchange for inclusion of unconditioned CA wildfire funding and a deal on the underlying appropriations levels for FY25, though they could make additional demands.  Democratic support will be necessary to offset defections from conservatives (e.g., Reps. Roy (R-TX), Biggs (R-AZ), Massie (R-KY) have already said they do not support this approach).  If the debt limit is not attached to the March appropriations bill, it will not be resolved until very close to the “X date” in June/July, given that the alternative would be to add it to the reconciliation bill that will be enacted at that point at the earliest.

* Speaker Johnson (R-LA) has continued to set expectations that they will reduce the deficit by $2.5t.  But, Senate Republicans have not yet weighed in and will presumably not be as aggressive about deficit reduction.  Rep. Roy, who is among the most influential conservatives on fiscal policy, has said that the “red line” is deficit neutrality, which signals a willingness to compromise.  Our current expectation is thus that the budget resolution that ultimately passes in both the House and Senate will require ~$1t in deficit reduction, and Republicans will point to tariff revenue to achieve the remainder of their deficit reduction target.  Whatever tariff revenue to which Republicans point will be derived from actions taken by President Trump, not Congress, as key Republican leaders (e.g., House Majority Leader Scalise (R-LA), Rep. Smith) have said tariff increases will not be included in legislation.

* It appears that Republican committee leaders (i.e., Senate Finance Chair Crapo (R-ID), Rep. Smith) support use of a current policy baseline, and we have not seen conservative objections to this approach, so we expect that it will be adopted.  If the budget resolution requires ~$1t in deficit reduction using a current policy baseline (i.e., no TCJA offsets), the deficit would be increasing by a net ~$4t on a “current law” basis (i.e., one that assumes extension of TCJA increases the deficit by ~$5t).

Watch for these developments… We are continuing to watch for indications of what conservatives (e.g., Rep. Roy) consider an acceptable level of deficit reduction for the reconciliation bill.  Regarding the debt limit and FY25 appropriations/disaster funding bill, we are watching for what Democratic leaders (e.g., Jeffries) demand in exchange for supporting it.