The 2023 budget: one last attempt at compromise before a policy deadlock hits

In the aftermath of the 2022 midterm elections, many observers believe that the most likely outcome for fiscal policy over the next two years will be stagnation. This comes after Democrats enacted major spending programs over the past two years to: (1) provide continued relief for the COVID-19 pandemic, (2) fund the increased public infrastructure bill in history and (3) salvaging parts of President Biden’s Build Back Better program in the Inflation Reduction Law that address climate change, health care, and tax reform. New authorized spending for these programs exceeds $3 billion.

Looking ahead, President Biden and the Democrats in Congress are fully aware that their ambitious agenda will have to be scaled back considerably as Republicans take control of the House of Representatives. With much lower-than-expected Republican gains, Rep. Kevin McCarthy’s (R-Calif.) status as House speaker is yet to be determined. But the influence of MAGA Republicans like Rep. Jim Jordan (R-Ohio) and Rep. Marjorie Taylor Greene (R-Ga.) will grow as they play prominent roles on House committees.

For their part, Democrats won a one-seat majority in the Senate when Raphael Warnock won the runoff in Georgia. But this was partially offset by Senator Decision by Kyrsten Sinema (D-Ariz.) change your affiliation from Democrat to Independent. The change is not expected to alter the balance of power in the Senate for two reasons: (1) Sinema previously acted independently when she voted against President Biden’s Build Back Better bill and other Democratic-sponsored legislation; and (2) he does not plan to meet with the Republicans.

Meanwhile, tight election results have prompted both sides to reach an agreement on finalizing the federal budget for fiscal year 2023. Senate Appropriations Chairman Patrick Leahy (D-Vt.) recently announced that a bipartisan framework it would pave the way for a $1.7 trillion omnibus spending bill to pass before Christmas. The plans details they were disclosed Monday in a bill that totaled 4,155 pages.

Previously, there had been talk that Republicans would try to block passage of the budget. But after failing to take the Senate and win back the House by a very narrow margin, the Republicans went into the lame duck session with a much weaker hand than they had expected. Consequently, they have abandoned plans to threaten to shut down the government or pass a series of short-term budget resolutions in favor of reaching an agreement.

The main issue holding the omnibus bill back was the disagreement between the two parties over national funding levels. The Republicans claimed that the Democrats had achieved their goals through previous bills; Democrats countered that additional social spending was needed to counter the effects of inflation.

One area they could agree on was defense spending. Last week, the Senate passed an $858 billion defense spending bill that was $45 billion more than Biden had sought. It also included $45 billion in assistance for Ukraine. An amendment proposed by Sen. Joe Manchin (DW.Va.) that would speed up the permit approval process for energy-related projects failed.

According to the Washington Post, the omnibus bill contains $773 for national programs, an increase of 5.5 percent over 2022. They include a significant increase in funding for veterans, child care programs, public infrastructure, and national manufacturing of computer chips. The total is less than what the Democrats were looking for, but they were willing to compromise because they understand that next year will be more difficult for them.

Although Senate Republicans were willing to commit to the 2023 budget, House Republican leaders urged members to block its passage until next year, when they will be in control. Despite his philosophical commitment to smaller government, federal spending has skyrocketed since the COVID-19 pandemic struck in 2020. Since then, 5 trillion dollars have been allocated to provide pandemic relief to individuals and families, businesses, state and local governments, and healthcare entities.

Over the past three years, federal spending has averaged about $4.5 trillion. It then surged 45 percent in 2020 and averaged close to $6 trillion over the past three years. This resulted in the federal budget deficit to GDP ratio setting a postwar record of 15% in 2020 and 12% in 2021. It has since fallen to around 6% of GDP in 2022, and the Baseline projections from the Congressional Budget Office see deficits of 4 to 6 percent over the next 10 years. They are well above the postwar average of 3 percent and imply a steady increase in outstanding public debt relative to GDP.

As a result, there is less room for the government to pursue countercyclical fiscal policies or social programs in case the economy goes into recession.

The initial response to the COVID pandemic was justified as businesses closed and the economy slumped, and has been credited with contributing to a strong recovery. However, both parties crossed the line by extending transfer payments to individuals and companies. Several studies have concluded that the additional payments to unemployed workers did not materially affect labor supply. Others see the massive increase in federal spending as contributing to rising inflation this year.

Since fiscal policy is likely to be on hold for the next two years, this leaves the Federal Reserve with the burden of deciding whether to ease monetary policy while inflation is well above its 2 percent target. In this sense, US politicians will be much more constrained if another unforeseen shock occurs.

Nicholas Sargen, Ph.D. is an economic consultant for Fort Washington Investment Advisors and is affiliated with the Darden School of Business at the University of Virginia. He is the co-author of three books, including “Investing in the Trump era: How economic policies impact financial markets.

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