Goldman Explains What The Supercommittee Failure Means
By now everyone knows that the Supercommittee is an official dud. But what does that really mean for the economy and the stock market? Goldman's Alec Phillips chimes in with one of the better explanations of what this means. "The fiscal super committee announced today (November 21) that it would not reach agreement, and that its deliberations had concluded. Super committee failure means that (1) there is greater risk that the payroll tax cut expires, though there is still a chance this could be attached to a year-end spending bill; (2) spending cuts in 2013 will be more severe than they would have been under a super committee agreement; but (3) spending in 2012 will remain unchanged versus previous expectations." As for the one item everyone wants to know more about, i.e., the US downgrade, here is Goldman's take: "No ratings downgrades for now, but another "negative outlook" seems possible. S&P and Moody's have indicated that they will not take negative action on the US sovereign rating due to the super committee's failure to agree. Fitch has not yet concluded its rating review, but indicated in August that the Super Committee's failure to reach agreement would likely result in negative ratings action, which most likely means moving the outlook on its AAA sovereign rating from stable to negative (this would place Fitch in an equivalent position to Moody's). Fitch has indicated it will conclude its review by the end of the November."
Fiscal Policy After the Super Committee, from Goldman Sachs
The super committee has officially announced that it has failed to reach agreement. Although the super committee's formal deadline is not until midnight on Wednesday, November 23, the rules that govern the super committee require that the Congressional Budget Office provide a final estimate of the budgetary effects of any agreement 48 hours ahead of a vote, which puts the effective deadline at midnight tonight and agreement apparently out of reach.
Going into this process, we saw two potential scenarios coming out of the super committee process: (1) no agreement whatsoever, or (2) a partial agreement reaching about halfway to the $1.2 trillion deficit reduction target, with the automatic spending cuts or other strategies used to make up the difference. We viewed the latter as more likely given (1) public pressure on lawmakers to reach basic agreement on key issues, (2) a modest amount of common ground between the parties on deficit reduction policies, and (3) the opportunity for both parties to get something they desired out of the super committee process. For Republicans, avoiding some of the automatic defense cuts was the most important source of motivation, while we thought Democrats would be swayed by potential extension of the payroll tax cut and possibly emergency unemployment benefits, along with perhaps some other jobs-focused provisions.
These motivations proved insufficient to overcome the broader political pressures each side faced going into a very competitive election year. Although House Speaker Boehner (R-OH) did late last week propose a package of $600bn as the basis for the partial agreement that had earlier seemed likely to us, its composition was far from what seemed likely to win agreement, and time to reach a deal ran out. We see the following as the most important implications of the super committee's failure to reach agreement.
1. Extending the payroll tax cut and emergency unemployment benefits just got harder… The payroll tax cut and emergency unemployment benefits expire at year end, unless Congress acts to extend them. The most obvious means for extension has been inclusion in the super committee package and failure to reach agreement has reduced the likelihood of extension of these provisions, for two reasons: (1) offsetting the cost of a payroll tax cut ($110bn/yr) and/or emergency unemployment benefits ($50bn/yr) extension is more difficult to do outside of the super committee process, where "creative accounting" such as the use of war savings would have been more easily tolerated by both parties, and (2) the political debate is likely to get more acrimonious following super committee failure, which could make it more difficult to agree on other items.
Our current economic forecast assumes extension of the payroll tax cut but not emergency unemployment insurance. While we have viewed the risks to this scenario as evenly balanced -- there had been some risk that they payroll risk might not be extended, but also a considerable chance that unemployment benefits might be extended at the last minute--the risk now appears to the downside. The probability of a payroll tax cut has declined, and the prospects of extension now hinge mainly on whether Democrats can increase support for an extension by addressing Republican priorities in the same legislation. However, most of the items Republicans would be likely to seek would also come with a cost, and such a package could quickly become too expensive to pass. Emergency unemployment benefits, which had seemed to be a close call before, now look more likely to expire, though extension is still, for now, part of post-super committee negotiations along with the payroll tax cut.
Additional clarity on the path forward on these issues may not come until next week. At that point, Congress will return from recess and congressional leaders will begin putting together the strategy to extend funding for government operations past December 16, when the current stopgap funding measure expires. If either the payroll tax cut or emergency unemployment benefits are likely to be extended, it is likely to occur as part of this year end spending legislation, which already looks likely to be the vehicle to take care of some smaller (and less controversial) items such as the annual "doc fix" to reverse a large scheduled cut in Medicare payments to physicians.
2. …But few other effects for 2012. Although the debt limit agreement reached in August (known formally as the Budget Control Act) cut spending by $25bn in FY2012 (slightly more on a calendar basis), that amount is already included in our forecast, and neither the automatic spending cuts nor any of the possible super committee scenarios would change this by more than a few billion dollars. Therefore, apart from the uncertainty around expiring stimulus provisions, the outcome of the super committee should have very little direct effect on fiscal policies in 2012.
Federal fiscal drag for 2012 may be decided in the next few weeks
3. Additional fiscal skirmishes are likely over the next year, but no major reforms are likely until after the 2012 election. The super committee's rules would have made any fiscal reforms it agreed to much easier to enact. Those expedited procedures disappear now that the super committee has failed. Their absence, along with the broader political tension between the parties, makes fiscal reform unlikely for the next year. In the meantime, additional debates are likely, since Congress will have to vote to appropriate funds more than once between now and the next election, and will also debate expiring tax measures. While those debates will serve as catalysts for the two parties to push their priorities, the likelihood of meaningful reforms coming out of those events seems very low.
4. No ratings downgrades for now, but another "negative outlook" seems possible. S&P and Moody's have indicated that they will not take negative action on the US sovereign rating due to the super committee's failure to agree. Fitch has not yet concluded its rating review, but indicated in August that the Super Committee's failure to reach agreement would likely result in negative ratings action, which most likely means moving the outlook on its AAA sovereign rating from stable to negative (this would place Fitch in an equivalent position to Moody's). Fitch has indicated it will conclude its review by the end of the November.
5. Automatic spending cuts in 2013 create new uncertainty. The automatic spending cuts that take place in 2013 (these are known as "sequestration" in Washington parlance) would reduce spending by roughly $75bn in 2013. Lawmakers may attempt to intervene to postpone or reverse some of these cuts; some Republicans have already said they will push to reverse the defense-related cuts in particular because they believe that they would unacceptably weaken the military. However, reversing them won't be easy and may not find sufficient support unless the savings they would have produced are replaced with new savings from another area. President Obama has also threatened to veto legislation that reverses the cuts without paying for them. Thus, members of Congress who support reversing the defense cuts would need to come up with savings elsewhere that are acceptable to a majority of Congress. Given the failure to agree on exactly this issue over the last few weeks, it is difficult to see how lawmakers would be able to reach agreement on it next year, closer to the election. If not, this issue would then become part of the post-election policy mix.
Automatic spending cuts loom in 2013
Effect on federal of automatic "sequester"; billions of current dollars and percent of GDP
6. The focus will soon turn to the year-end 2012 debate. Once Congress decides whether to extend the payroll tax cut and emergency unemployment benefits, the focus is likely to turn to the even larger issues that will need to be addressed at the end of 2012: (1) the likely attempt to undo the automatic spending cuts that kick in in January 2013, (2) the expiration of the 2001/2003 tax cuts after December 2012, and (3) the need to increase the debt limit, which will hit in late 2012 or early 2013 (the exact timing will depend on revenue patterns and policy choices). There are too many potential scenarios to list here, since decisions yet to be made this year that will affect next year's debate, as will the upcoming election. However, the amount of expiring policies and spending cuts set to take effect over the next few years is large, as shown in the table below. These numbers highlight the fact that the risk from a political impasse is not only that Congress fails to enact long-term fiscal reforms, but also that it fails to extend current policies and in doing so adds to the drag on growth from fiscal policy.