This is the third of three posts on the Budget Control Act.

The other two posts are:

  1. Quick summary of the Budget Control Act; and
  2. Understanding the Budget Control Act.

I cover three topics in this post: what important players won in this deal, the core concepts and tradeoffs within the deal, and what the different strategies might be this Fall under this bill if (when?) it becomes law.

The President’s priorities

The President knows he will get debt limit increases through early 2013 no matter what House conservatives/Tea Party members do. Those Members can no longer “hold a debt limit increase hostage” before the 2012 election.

We could also describe this as eliminating liquidity risk through 2012.

Assuming someone doesn’t find a way out of the enforcement mechanisms in the bill (1 in 3 chance), there will be at least $2.1 T in deficit reduction over the next 10 years as a result. While I think that’s a big policy benefit, I’m not sure how important that is substantively to the President. (Is he for stimulus? Austerity? Who knows at this point.)

But given his recent public conversion to deficit hawk, the President will undoubtedly stress it publicly over the next 18 months and began doing so last night. At a minimum, the President will benefit politically with deficit hawk centrists, both for the policy result and the achievement of a bipartisan agreement. Prepare to watch the President seize political credit for spending cuts he fought.

The President also has an opportunity to push for tax increases as part of the Joint Committee deficit reduction process this fall. You will hear the corporate jets & Big Oil riffs ad nauseam.

Republican / conservative / Tea Party priorities

The Speaker set a goal for House Republicans of at least a dollar of spending cuts for each dollar of debt limit increase. This law guarantees at least a dollar of deficit reduction for each dollar of debt limit increase. Thus this law guarantees at least $2.1 T in deficit reduction over the next 10 years. That’s not $4 T but it’s not bad in a balanced Washington.

Of that deficit reduction, at least $917 B of it is from spending cuts and discretionary spending caps, and House Republicans can guarantee that it all comes from spending cuts and caps if they are willing to threaten to cut defense a lot (which is different than actually cutting defense a lot). Through this law Republicans have the opportunity to lock in at least $2.1 T in spending cuts over the next 10 years. The spending caps will be in law and enforced with a sequester, meaning they are not gimmicks. Yes, a future Congress can change the law and undo those caps, but the same is true for any policy change.

While the Joint Committee process does not preclude tax increases cuts, it is tilted pretty heavily against them and toward spending cuts. That is huge.

The tax rate and cap gains & dividends fights probably shift to outside this Joint Committee process. I expect a recurrence of the 2010 fight in 2012, this time with the President threatening a veto. The use of a current law baseline for revenues in this fight is a rhetorical but not a procedural concession. My money remains on another extension of current rates and no tax rate increases in 2013. The underlying political pressures are unchanged.

The Balanced Budget Act will get a vote this fall in the Senate, and there is a modest financial incentive (a higher debt limit increase) for the Senate to pass it. I still think it’s unlikely this will be sent to the States, but this is a process improvement relative to where they are now on a BBA.

Congressional Democrats’ priorities

In addition to the goals listed above for the President, Senate Democrats get to punt this year and next on passing a budget resolution and making any politically difficult choices in the open. This is for me the only unequivocally bad part of this bill. It is process abuse, in which Senate Democrats are avoiding taking responsibility for proposing solutions to America’s biggest economic policy problems.

Core concepts & tradeoffs

  • The President avoids another debt limit battle before his election. (Hey, he framed it this way.)
  • Republicans get >$2T of deficit reduction and the ability to block tax increases and force spending cuts.
  • This fall Democrats will face a hard choice: cut the big entitlements or cut domestic discretionary spending even further?
  • This fall Republicans will face a hard decision: are you willing to taking the chance that defense discretionary will be cut even more deeply to avoid tax increases?

The new trigger mechanism is the key to this new deal and the fall battle.  The trigger makes tax increases quite difficult (should make Rs happy), provides no benefit to raising tax rates (Rs even happier) but doesn’t rule out targeted tax increases (should minimally satisfy Ds). The trigger cuts defense spending more deeply than nondefense spending, in theory creating greater pressure on Republicans than on Democrats to want the Joint Committee process to succeed.

I think Team Obama thinks, because a failed Joint Committee would cause the trigger to cut defense spending an additional 10% and nondefense discretionary spending “only” an additional 8%, that Republicans will pay anything to get a new law, including agreeing to tax increases. I think Congressional Republicans think this judgment is wrong, and this difference of opinion allows both sides to agree to this trigger and this new law.

The President’s strategy for the fall Joint Committee battle

The President is telegraphing his strategy. He will threaten to oppose (veto?) any product of the Joint Committee that does not raise taxes on his favorite targets (“balance”). In doing so, he will be threatening something valuable to most Republicans: defense spending. While last spring Tea Party conservatives took a debt limit increase hostage to force Democrats to cut spending, this fall the President will take national security spending hostage to (try to) force Republicans to raise taxes on politically unpopular constituencies.

A Republican counter-strategy

There is a simple Republican counter strategy available:

  • Speaker Boehner and Leader McConnell appoint to the Joint Committee six Members who will not raise taxes.
  • These six Republicans call the President’s bluff, and tell their Democratic counterparts they are willing to reject a deal that includes tax increases, even if that deal means the trigger will cut defense deeply. They deny the six Democratic Members of the Committee negotiating leverage from the difference between a triggered 10% cut in defense and an 8% cut in nondefense discretionary spending. “This is going to hurt you almost as much as it’s going to hurt me, so I’m not giving you anything to avoid it.”
  • These six Republicans encourage everyone to cooperate to get most (all?) of the $1.5 T in deficit reduction from the Big 3 entitlement programs: Social Security, Medicare, and Medicaid. They are the cause of our long-term fiscal problems and they are so big and growing so rapidly that you can save lots by changing them.

I am reminded of the familiar scene in an action movie. The bad guy holds a hostage and a hand grenade while our hero, five feet away, points a gun at the bad guy. The bad guy threatens to pull the grenade pin and kill himself, the hostage, and our hero. He points out that the hero may not care about himself, but surely he doesn’t want to risk the life of this innocent young girl.

The hero, who we know is a kind and compassionate man, looks the bad guy straight in the eye and says, “Go ahead. Blow us all up. I don’t care about her, and I don’t care about myself, as long as you’re killed in the process as well. We both know you won’t pull that pin because you won’t kill yourself. So let her go and let’s end this peacefully.” The bad guy backs down because the hero has demonstrated the threat provides no relative advantage. As long as the exploding grenade would do sufficient damage to the bad guy (death), it doesn’t matter that the hero suffers a greater loss (death X 2). The bad guy doesn’t want to carry through with his threat any more than the hero does.

(I am not suggesting the President is a bad guy with a grenade.  It is just a metaphor to illustrate a negotiating concept.)

The same is true here. An additional 10% cut to defense discretionary is deep, and many Republicans will intensely want to avoid it. At the same time, an additional 8% cut in nondefense discretionary will freak out many Congressional Democrats and the White House, and they will intensely want to avoid it. I think the depth of both cuts are so deep, and the difference between -10% and -8% is small enough, that it confers no relative advantage in the Joint Committee. Democratic negotiators will be just as desperate to avoid 8% domestic discretionary cuts as Republicans will be to avoid 10% defense cuts.

This means that all Republicans need to do is call the President’s/Democrats’ bluff on tax increases, threaten to allow the pain of the trigger hit both sides, offer $1.5 T of entitlement spending cuts, and wait.

$2 trillion of spending cuts is big for Congress but small relative to our underlying fiscal problems. If this bill becomes law and if the fall Joint Committee process is successful, the remaining spending problem will be more than an order of magnitude larger than this accomplishment. If you think this summer has been painful or dread the battle of this fall, you ain’t seen nothin’ yet. Wait until Congress wrestles with the big stuff.

Three times in the past year Congressional Republicans have played brinksmanship with the President and come out ahead:  the December 2010 tax rate fight, the Spring 2011 CR fight, and now the Summer 2011 debt limit fight. They have a game plan that has delivered multiple incremental wins so far, and a playing field that favors them for the Fall 2011 Joint Committee fight. In a balanced Washington they have successfully leveraged a debt limit increase to cut spending and not raise taxes.

For these reasons I am fairly optimistic this bill provides an opportunity for another incremental win this fall. If I’m right, it also establishes a pattern for when the debt limit expires in 2013.

(photo credit: Andrew Magill)