The Looming Budget Battles

It's that time of year again.

The Washington press likes to complain that "nothing gets done" in the capital these days. Since the 2010 election, a Democrat president can veto any Republican initiative and the Republican House can refuse to enact any Democrat proposal. Stalemate. Gridlock. Partisan bickering.

This is a dramatic change from 2009 and 2010, when Democrats held the presidency and a supermajority in the House and Senate and were able to pass the $800 billion "stimulus" spending program, the 2,700-page "Affordable Care Act" that included twenty tax hikes, added over twenty thousand pages to the Federal Register, and drove federal spending from $3.17 trillion in 2008 to $3.56 trillion in 2012.

Two years of dramatic increases in the size and power of government and then two and a half years of "sitzkreig."

But we are approaching some action forcing deadlines. The federal budget is supposed to be approved by October 1, 2013, and this fall the growing federal deficit will require yet another increase in the $16.7 trillion debt ceiling. Both the budget and the debt ceiling will require the House, Senate and president to talk and actually agree on specific legislation.

Congress will most likely pass a continuing resolution (CR) rather than a fleshed-out budget. Why? First, the Democrat Senate wants to spend a great deal more than the Republican House. But even if the House and Senate could agree on a total spending number they have radically different views on how to allocate federal spending—on defense vs. food stamps, for example.

The 2011 struggle over the debt ceiling created a framework that shapes this year's debate. Total federal spending is limited by the Budget Control Act (BCA) of 2011 with its caps and sequester...unless Obama can convince the Republican House to "bust the caps" and spend more.

Republicans believe the continuing resolution and debt ceiling give them "leverage." They remember that they forced President Obama to cut spending repeatedly in early 2011 by passing short term CRs with small budget cuts inside. The Republican cuts were targeted—often including cuts Obama had publicly claimed to support—and small enough that Obama could not justify "closing the government" in response. Republicans also remember that in 2011 they forced Obama to sign the BCA cutting $2.5 trillion from his spending plans in return for a $2.5 trillion hike in the debt ceiling.

Republicans will be looking to "force" the Democrat Senate and the president to "give them something" in return for passing a CR and increasing the debt ceiling. Thirteen conservative Senate Republicans have "demanded" that Obamacare be completely defunded in any CR. While Obamacare remains unpopular—77 percent of Americans want the individual mandate repealed—President Obama is more likely to trade away his liver than the prized legislative victory he views as his lasting legacy.

A second possible Republican demand would be to delay Obamacare for one year. This may be the compromise. Obama has already begun to delay certain parts of Obamacare for big business, individual labor unions and insurance companies. Special deals for a few is hard to justify legally or politically. Democrat senators up for reelection in 2014 might welcome the delay of what Senator Max Baucus referred to as the coming "train wreck" of implementation of Obamacare. Obama could agree to a one-year delay without feeling he was walking away from his legislation. Delay is not surrender.

Obama would like to get Republicans to agree to lift the spending caps in the BCA. For a year, he has given speeches suggesting that the caps would lead to disaster, but this tactic has not worked. Threatening to cancel the White House Easter Egg Hunt and White House tours for high-school students backfired. Obama assumed that Republicans would be willing to raise taxes to avoid the sequester limits on Pentagon spending. But the "Pentagon budget is sacrosanct as is" caucus turned out to be much smaller than he imagined.

There remains one possible goodie Obama is dangling before the Republicans hoping to get them to raise taxes and give away the spending limits: tax reform.

The corporate income-tax rate stands at 35 percent. The average in the OECD nations is 25 percent. China is at 25 percent. Canada is at 17.5 percent. This is a serious drag on the American economy.

Obama offers to reduce the rate in return for other tax hikes that would on net raise about a trillion dollars over the next decade. Senator Reid has seconded this, promising/threatening that any tax reform that does not raise about a trillion in higher taxes would never see the light of day in the Senate.

This is almost certainly a dead end. Republicans do want tax reform, but not a tax reform that serves as a Trojan horse for a trillion-dollar tax hike.

Instead, House Ways and Means chairman Dave Camp is moving forward with a tax reform that will bring individual and corporate rates down to 25 percent without raising overall taxes. His tax reform will be scored both on the traditional static model—assuming that lower rates will have zero effect on behavior—as well as with a dynamic score that presumes people and businesses actually do react to changes in tax law.

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