GOLDMAN: The Odds Of A Small Fiscal Deal Is On The Rise

Goldman’s Alec Phillips writes in a note to clients that the odds of Congress reaching some kind of “small bargain” is on the rise.

It’s way too hopeful to imagine that Congress in this environment would ever be able to reach a broad deal on spending, entitlement, and taxes. But, says Phillips, there’s a decent and growing chance that Congress will agree to prevent another set of spending cuts from coming into force in 2014.

See, current law (“The Sequester”) envisions another $US19 billion in annual spending cuts starting next year. Phillips thinks those can be reversed for a few reasons.

One key thing is that the cuts will primarily fall on defence spending in 2014, which could increase GOP motivation to reverse them.

The dollar amounts are small. To maintain the current (smaller) sequester cut for another year, lawmakers will probably need to agree on $US19bn in offsetting savings elsewhere in the budget. These savings could be spread over 10 years and could be found through a variety of smaller policy changes. While it seems that nothing is easy in Washington these days, finding $US19bn in a budget projected to take in $US40 trillion and spend $US47 trillion over the next 10 years should be easier to resolve than a lot of other problems before Congress.

A small deal could sidestep the tax vs. spending issue that has blocked so many prior agreements. Prior broad fiscal negotiations have gotten hung up on tax increases (Republicans generally oppose them) and entitlement spending cuts (Democrats generally oppose them unless coupled with tax increases). A small deal could might skip both sets of issues and instead focus on spending that does not affect entitlement benefit and revenue that does not affect the tax code (for example by raising user fees). For example, the farm bill alone, versions of which have passed the House and Senate, would reduce spending by a projected $US20bn to $US30bn over the next 10 years. Defence cuts are likely to increase motivation to reach a deal.

Due to quirks in the law, the cuts fell more heavily on non-defence spending in FY2013, and but will fall equally on defence and non-defence spending in 2014. The upshot is that almost the entire incremental cut for 2014 applies to defence. This may increase Republican interest in an agreement.

On this last point, the initial hope when the sequester was put into place in 2011 was that the GOP would find the defence cuts to be so odious that they would be eager to remove the sequester entirely, but that didn’t pan out. The pro-defence hawkish element within the GOP that really cares about this stuff isn’t as big of a force as it used to be, and the party was happy to leave in place all the cuts. That being said, if the majority of cuts in 2014 fall upon defence, maybe the party will be more inclined to do something. At least that’s Phillips’ reasoning.

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