Macro update (reconciliation)
Recent/upcoming developments… Now that the House and Senate Republicans have each passed their own versions of a budget resolution, negotiations will commence in the coming days on adopting a joint resolution. This resolution establishes the allowable deficit parameters of subsequent “reconciliation” legislation that will make changes to taxes/spending. While Senate Republican leaders are indicating they want to see changes to the House resolution, they are effectively acknowledging that they are now pursuing a single-bill strategy for reconciliation (i.e., one large-scale bill that includes extension of the expiring provisions of the 2017 TCJA, other tax cuts called for by President Trump, border/defense spending, spending cuts) rather than the two-bill strategy that the Senate has pursued up to this point. The primary priority for Senate Republicans is ensuring that the reconciliation legislation will make the TCJA permanent, and numerous of them are signaling a desire to soften some of the spending cuts implied by the House budget resolution. Meanwhile, Speaker Johnson (R-LA) is signaling that the reality of his narrow House majority is that the budget resolution cannot change much from what was adopted in that chamber. He also visibly indicated for the first time that he supports use of a so-called “current policy baseline,” which would treat extension of the expiring provisions of the TCJA as just preserving the status quo, thereby not increasing the deficit, and not requiring offsetting spending reductions. Johnson also continues to assure moderate Republicans that the changes to Medicaid implied by the House budget resolution will not be structural in nature and won’t impact beneficiaries (i.e., he appeared to rule out per-capita caps and changes to the federal/state matching formula (FMAP)).
* The House budget resolution allows for $4.5t in tax cuts and $300b in spending increases, while requiring $1.5t in spending cuts. If $2t in spending cuts aren’t achieved, then the allowable tax cuts decline by that amount. Fiscal hawks are comfortable that the budget resolution allows for a net $2.8-3.3t deficit increase as long as spending cuts are adopted. The House budget resolution directs $880b of the spending reductions be provided by the Energy and Commerce (E&C) Committee, implying that would mostly come from Medicaid, along with cuts to clean tech spending and revenue generated from spectrum auctions. It also directs $330b in cuts to be provided by the Education and Workforce Committee, implying that would mostly come from eliminating the Biden student loan debt forgiveness programs and reforming student lending. And, it directs $230b in cuts to be provided by the Agriculture Committee, implying that would mostly come from reductions in food stamp (SNAP) spending.
* Echoing the concerns of House moderates, some Senate Republicans (e.g., populists such as Sen. Hawley (R-MO) and agriculture policy leaders such as Sen. Boozman (R-AR)) are raising concerns about any cuts to Medicaid that would impact beneficiaries as well as about cuts to food stamps. Another indicator of the Senate’s more fiscally expansive orientation is that Republicans in that chamber rejected an amendment to their budget resolution offered by Sen. Paul (R-KY) that would have required $1.5t in spending cuts (i.e., 29 Republicans voted against it).
* In order to achieve significant Medicaid savings without making structural changes such as instituting per capita caps and changing FMAP, Republicans would need to be successful in characterizing other major changes as limited to addressing “waste, fraud, and abuse” and being comfortable the changes don’t impact beneficiaries. These other potential changes include imposition of work requirements ($110b), repealing the 80/20 home and community-based services rule ($121b), repealing Biden-era Medicaid eligibility rules ($80b), constraining provider taxes ($48b to $241b), and repealing the Biden-era state-directed payment (SDP) rule ($35b to $168b).
* Achieving TCJA permanency would have an ~$4.6t deficit impact, and eliminating taxes on tips would have an ~$300b deficit impact. Note that among his various proposed tax cuts, Trump has prioritized elimination of taxes on tips, though has also continued to express interest in eliminating taxes on overtime ($2.t deficit impact) and Social Security ($1.2t deficit impact). Use of a current policy baseline, whereby there would be no need for offsetting the $4.6t necessary to make TCJA permanent, would reduce pressure to find aggressive spending cuts and would also allow Republicans to include more of Trump’s additionally proposed tax cuts in the bill.
* In addition to considering use of a current policy baseline, Johnson has also said Republicans are exploring ways to count tariff revenue and DOGE-related savings in order to meet the deficit parameters called for in the House budget resolution. As we’ve noted, leading Republicans have made clear they are not going to legislate tariff increases, and DOGE actions are not legislative in nature, so any use of these concepts in the budget resolution would require that language be included that manipulates the budget baseline in some way. While potentially procedurally possible, it would be necessary for fiscal hawks to view this as sufficiently credible.
Our outlook… We had anticipated House Republicans would adopt a budget resolution for a single-bill strategy and that would create sufficient momentum such that the Senate would do so as well. Given this, we see no changes to our pre-existing timeline estimate for enactment of reconciliation legislation… adoption of a joint House/Senate budget resolution by the end of Q1, House/Senate committee consideration of the underlying reconciliation legislation in Q2, passage on the floor of the House/Senate in Q3, and merging of the respective House/Senate bills and enactment in Q4. If we see a high degree of alignment between the two chambers as committees begin their work, this timeline could accelerate. The only deadlines Republicans face are expiration of various TCJA provisions on 12/31 and the need to address the debt limit by June/July (see separate update below). To the degree that the budget resolution changes once the Senate weighs in, it will likely become more fiscally expansive, but we do not anticipate significant change, given the delicate balancing of interests that was necessary for its adoption in the House.
* Republicans have long pointed to the concept of a current policy baseline in justifying not offsetting extensions of expiring tax provisions. However, it’s never been formally required as the means for scoring (accounting for) a reconciliation bill (referred to as being used for “budget enforcement”). In recent months, leading Republicans (e.g., Senate Finance Committee Chair Crapo (R-ID), House Ways and Means Committee Chair Smith (R-MO)) and Treasury Secretary Bessent have advocated for using a current policy baseline. Some conservative fiscal hawks (e.g., Rep. Roy (R-TX)) have signaled they are open to it, but others (e.g., Sen. Cassidy (R-LA)) have expressed reservations. Use of a current policy baseline will likely require a strong push by the White House/administration and Republicans leaders, in order to overcome reservations that exist among fiscal hawks.
Watch for these developments… As House/Senate negotiations over a joint budget resolution unfold over the next one-to-two weeks, we are watching for indications that they are converging on a framework that allows for TCJA permanency, and that moderates/populists are comfortable with implied cuts to Medicaid, food stamps and other programs, while preserving sufficient spending reductions that conservatives remain satisfied. We are also watching for indications that fiscal hawks are comfortable using a current policy baseline