Ryan Versus Obama; Budget Plans Mean Fiscal Tightening Either Way
Republican Presidential candidate Mitt Romney's selection of Rep. Paul Ryan (R-WI) as his running mate has generated renewed interest in the House-passed budget resolution that Ryan authored. Ryan's budget outline would reduce the deficit more quickly and impose more fiscal restraint than the President's budget proposal. However, as Goldman notes. while both proposals would increase revenues due to the scheduled expiration of the payroll tax cut at year end, the President's would raise income taxes as well. Rep. Ryan's plan, on the other hand, would cut spending sharply in 2013 and 2014, even though it assumes a one-year delay in the spending cuts under the "sequester" set to take effect at year-end.
Goldman Sachs: The President's Budget and the Ryan Plan: Fiscal Tightening Either Way
Republican Presidential candidate Mitt Romney announced on Saturday, August 11 that he has selected Rep. Paul Ryan, the Republican Chairman of the House Budget Committee, as his running mate. The selection of Rep. Ryan is notable because (1) he is more clearly associated with specific policy stances than most prior vice presidential candidates, and (2) the fiscal policy issues for which he is known also happen a key issue in the campaign as well as one of the key areas of economic uncertainty in the coming year. Market participants thus appear to be more interested than usual in the implications of the vice-presidential selection, particularly in light of the "fiscal cliff" at year end and the prospects for broader fiscal reforms in 2013.
While the selection of Rep. Ryan for the Republican ticket is very likely to increase the focus on fiscal issues in the presidential campaign, and thus might prompt increased discussion of the "fiscal cliff" on the campaign trail, this should have little bearing on the resolution of these issues at year end. We continue to believe that the economic effects of allowing the fiscal cliff to take effect in full will be the greatest motivation for members of Congress to reach an agreement.
On the other hand, Gov. Romney's vice-presidential selection is likely to increase the campaign focus on medium-term deficit reduction. Exhibit 1 below shows the fiscal path under (1) Rep. Ryan's budget plan, (2) the President's proposal, and (3) an extension of current policy. To calculate the path under current policy, we start with the Congressional Budget Office's (CBO) alternative scenario, which assumes extension of all expiring income tax cuts, and continued relief from the alternative minimum tax (AMT) and scheduled Medicare physician payment cuts. We make three further adjustments to reach a path equivalent with extending current policy: we assume (1) extension of the payroll tax cut, (2) a drawdown of troops overseas similar to the President's budget, and (3) an extension of emergency unemployment benefits. Even with these extensions, this path still brings the budget closer to balance due to cyclical improvement and some fiscal restraint built into current law.
Against this scenario, we compare the two other proposals. The first is the President's budget submission to Congress in February, which includes the recommendations on deficit reduction made to the "super committee" last year. The second is Rep. Ryan's "Path to Prosperity" proposal, which was the basis for the annual budget resolution the House passed earlier this year. The formats of these proposals are thus quite different, though both have shortcomings. The President's budget is very detailed, but relies on internal White House economic projections. For this reason, we rely on the Congressional Budget Office's re-estimate of the President's budget, which applies CBO's economic assumptions. Those economic assumptions are also implicit in Rep. Ryan's plan, but his plan comes in the form of an annual congressional budget resolution, a piece of legislation which typically includes few specifics and projects top-line revenue levels and spending by broad functional category. While Rep. Ryan has published additional details that go beyond what is in the legislation itself, some sources of savings are nevertheless not entirely clear.
Both proposals would reduce the deficit significantly relative to current policy. The President's would bring the budget nearly to primary balance (i.e., spending excluding interest expense would be nearly equal to revenues). Rep. Ryan's budget resolution goes well beyond this, proposing to bring the deficit to primary (ex-interest) balance by mid-decade. Assuming that the Treasury's average borrowing rate is roughly equal to nominal GDP growth, bringing the budget into primary balance should be enough to stabilize the debt-to-GDP ratio, with the primary surplus the Ryan plan proposes in the second half of the decade enough to reduce it.
Exhibit 1: President's budget would nearly eliminate primary deficit, while Ryan proposes a primary surplus
The fiscal path under Rep. Ryan's budget resolution would be achieved through more dramatic deficit reduction in the near term. Exhibit 2 shows the year-over-year change in the primary balance projected under the two plans, along with the path we have calculated that follows the current policy. While the President's plan and the Ryan plan would tighten fiscal policy in 2013, the Ryan plan would tighten fiscal policy by 2.6% of GDP from fiscal year (FY) 2013 versus FY2012. The President's plan would also tighten fiscal policy considerably in 2013, by 1.4% of GDP. Some of this deficit reduction represents cyclical improvement, though most of it is related to policy changes.
Exhibit 2: Compared with current policy, both proposals would impose greater fiscal restraint in 2013 and 2014
Beyond the pace of deficit reduction, the composition of deficit reduction would differ significantly under the two plans. Exhibit 3 shows that both plans call for an increase in tax revenues in FY2013, due in large part to the scheduled expiration of the payroll tax cut, which neither proposal would extend. The President's proposal would also allow the tax cuts on household income over $250,000 to expire and it would impose new limitations on tax deductions and exclusions for upper-income taxpayers; the effect of these tax increases continue into 2014, when tax returns for 2013 are due. In our own estimates, we assume that the payroll tax cut will indeed be allowed to expire at year end, though we assume that the 2001/2003 tax cuts will be extended into 2013.
Exhibit 3: Revenues would rise under both proposals in 2013, but would keep rising under the President's budget
Rep. Ryan's budget plan would reduce spending by 1.2% and 1.3% of GDP in FY2013 and FY2014, respectively, compared with modest reductions in spending (as a share of GDP) under the President's proposal. This is despite the fact that his plan would reverse most of the spending cut planned under "sequestration" in 2013, with other cuts spread out over the next ten years (the President's budget assumes that the sequester is not implemented).
As we have noted before, what is remarkable about the two proposals is how modest the savings are from Medicare and Social Security--two programs critical to the longer-term fiscal outlook--in both plans. While both proposals propose incremental reductions in Medicare expenditures versus current policy over the next ten years--the Ryan plan calls for a slightly greater amount--the differences in projected spending are minor. The Ryan plan involves more significant changes to the structure of Medicare later on, but these would not take effect until outside the 10-year window Congress uses to evaluate fiscal policy.
The differences in other programs are in fact much more notable in the near term. The House-passed budget envisions repeal of most of the Affordable Care Act (ACA), excluding the cuts to Medicare payments used to finance some of the cost. This would reduce Medicaid spending projections substantially, as would the Ryan plan's proposal to shift Medicaid to a "block grant" indexed to inflation and population growth but no longer tied to state health expenditures. The food stamp program would also be shifted to a block grant, starting in 2016, and projected spending in a number of other programs in the "mandatory" segment of the budget would be reduced.
Exhibit 4: Spending would come down more quickly under Ryan budget
Aspects of either plan could conceivably become law. If either party controls both chambers of Congress and the White House, that party would be able to take advantage of the budget "reconciliation" process. This involves two steps: (1) passage of a budget resolution that instructs various congressional committees to meet certain spending and revenue targets; and (2) passage of legislation produced by the committees to carry out those instructions. Reconciliation could potentially be a very important tool, since it allows legislation dealing with fiscal policy--generally this means tax changes or modifications to "mandatory" spending programs--to pass the Senate with a simple majority and free from filibuster and other procedural obstructions that usually take 60 votes to clear. In theory, if Gov. Romney were to win the White House with a slim Republican majority in the Senate, Republicans would be able to use reconciliation to pass a good deal of the Ryan proposal, including extension of expiring tax cuts, repeal of most of the Affordable Care Act (ACA) and other spending cuts.
While the reconciliation process is a powerful tool, two aspects of that process could result in less fiscal restraint in 2013 than proposed under Rep. Ryan's plan. First, a few politically centrist Republican members of Congress might advocate for smaller spending cuts, and if the Republican majority in the House or Senate were very slim this could be enough to lead to changes in the proposal. Second, the budget process and reconciliation process typically occur in the spring and summer, respectively, so policy changes might not be enacted until mid-2013 in such a scenario.
If the President wins reelection and/or Democrats hold their majority in the Senate, a bipartisan compromise would be necessary to enact fiscal reforms. This has been difficult to achieve over the last year or so and we expect compromise to be even tougher as some of the less controversial options for deficit reduction were enacted as part of last year's debt limit compromise and thus no longer available. That said, it is becoming increasingly clear that resolving the disagreement over pending fiscal issues--the expiring tax cuts, the sequester, and how to address the next increase in the debt limit that will become necessary in early 2013--could be easier in the context of a broader fiscal agreement that deals with tax and entitlement reform and moves beyond, for example, the binary question of whether to extend the tax cuts on upper incomes. So even if neither party has the unilateral ability to push through fiscal changes, it seems likely that some deficit reduction measures will be enacted in 2013.