Macro update (reconciliation (tax/spending, border/defense, health care))

Recent/upcoming developments… House Republican leaders are struggling to take the first step in the process of passing their “reconciliation” (tax/spending) legislation, which is to pass a “budget resolution” that defines how the reconciliation bill will impact the deficit.  Conservatives want the bill to reduce the deficit more aggressively than Republican leaders feel is politically feasible.  Meanwhile, Senate Republicans still want to pass two reconciliation bills this year, with the first focused on border/defense funding, and energy reforms, and the second focused on extending the expiring provisions of the 2017 Tax Cuts and Jobs Act (TCJA), other tax cuts, and various spending cuts.  President Trump has implied he prefers a single bill, but is open to a two-bill strategy.

* The first step in adopting the budget resolution is to pass it in the House Budget Committee, where Republicans can only lose two votes.  However, numerous members of the conservative House Freedom Caucus are on the Budget Committee (e.g., Reps. Roy (R-TX), Norman (R-SC)) and are blocking action until their demands are met.  Republican leaders could skip consideration of the budget resolution at the committee level, but their vote margin similarly narrow on the House floor, where conservatives thus have the same leverage.

* Speaker Johnson (R-LA) initially proposed cuts of ~$500-700b.  While conservatives are calling for cuts of ~2t+, they have previously signaled that cuts of ~$1t would be acceptable.  Majority Leader Scalise (R-LA) has indicated that negotiations are getting close to reaching that level.

* Senate Majority Leader Thune (R-SD), Budget Committee Chair Graham (R-SC), and other Senate Republicans have said they are prepared to move forward with an initial reconciliation bill focused on border/defense funding, which would be fully offset by energy leasing revenue and possibly other provisions.  They are apparently contemplating border security funding of ~$100b and defense funding of ~$200b.

Our outlook… Our expectation remains that ultimately, the House’s strategy will prevail, and that Republicans will pass a single reconciliation bill.  But our confidence about this view has dropped (now at 60% probability they’ll adopt a single bill), given the difficulty House Republican leaders are having with the budget resolution.  If they have to capitulate to the Senate’s position and try to pass two bills, there will be two implications… first, the timeline for enactment of the tax/spending cut components of the bill will shift more clearly to Q4, and second, the probability of Republicans being able to enact a large-scale tax/spending cut bill will begin to drop, and the potential for a short-term extension of TCJA/more limited spending cuts will begin to rise.  Our expectation remains that in the single bill scenario, the legislation will reduce the deficit by ~$1t against a “current policy baseline” that assumes an extension of the TCJA just preserves the status quo and doesn’t count its ~$5t impact on a “current law” basis.

* A variety of lists of potential spending cuts for the Republican reconciliation bill have circulated in recent weeks, but they’ve not reflected political feasibility.  The following cuts/revenue increases are reportedly under active consideration, and in our view, are politically feasible.  I’ve noted below their estimated budgetary impact over ten years, which totals $1.2t (source: Center for Responsible Federal Budget).

– Repeal some IRA clean energy credits… $216b

– Spectrum auctions… $100b

– Student lending/debt forgiveness cuts… $530b

– Waste, fraud, abuse… $100b

– Cut IRA energy spending… $50b

– Impose work requirements on food stamps, welfare… $100b

– Medicaid work requirements… $109b

* Republicans will likely also point to generous economic growth assumptions and tariff revenue (which as we’ve noted, is unlikely to be formally included in the bill) in order to characterize the total deficit impact of their policies as achieving closer to the ~$2t in deficit reduction that conservatives want to see.

* Republicans will also need to make decisions in the coming weeks about how to handle the additional tax cuts advocated by Trump, particularly exempting taxes on tips and lowering the tax rate on domestic producers, which are the two on which he appears to be most focused.  We continue to believe Republicans will include a tax exemption for tips in the bill, and it’s possible they’ll also adopt a tax cut for domestic producers, though it has less resonance in Congress.  Each have an ~$200b impact on the deficit.  They will also need to decide how to address enhanced ACA subsidies that expire at the end of the year, which if extended fully, have an ~$550b deficit impact.  As we’ve noted, numerous Republicans have implied they want to see these subsidies partially extended, which we continue to believe is the likely outcome.  If conservatives push for a net deficit impact for the overall bill of more than $1t, the likelihood of these provisions being included will drop.

Watch for these developments… We appear to be reaching a key decision point as to whether Republicans will pursue a one or two bill reconciliation strategy.  Senate Republicans are meeting with Trump in FL this weekend at which they will discuss this, among other issues.  If we get indications that Senate Republicans are planning to consider the budget resolution for their initial, smaller reconciliation bill before House Republicans do so, it will be an indication that a two-bill strategy is now more likely.