Why Everyone Punted on the Sequester

Deal
In a rare moment of bipartisanship, Rep. Paul Ryan (R-WI) and Sen. Patty Murray (D-WA) this past week reached a budget compromise that is actually quite moderate in nature.

Conservatives got the two things that were most critical to them - no tax increases (although there were some fee increases, which I feel are defacto tax increases - more on that later) and restoration of some of the sequester budget cuts.

Liberals got two more years without entitlement cuts as the agreement leaves Social Security, Medicare and Medicaid untouched.  They also got higher overall spending caps (by $63 billion) over the next two years than the sequester allowed, although part of that increase will go to defense.

In theory, the package is deficit reducing, but probably not in reality.  The package allowed $63 billion in additional spending over the next two years, offset by $85 billion in cuts (primarily from federal workers and military pension contribution changes) and fee increases (most notably an increase in the fee on airline tickets) over the next 10 years.  So if the world stays utterly static over the next ten years, the deficit will go down, but the reality is that the package increases the deficit by $45 billion over the next two years versus the sequester agreement and it is a near 100% certainty that budgeting over the following 8 years will change.

This is a small-ball bargain that largely preserves the status quo.  It does not touch in any meaningful way the three biggest drivers of the deficit, which are entitlement spending, defense spending and revenues.  But that might actually be okay - the federal budget last year was $680 billion, way down from the recession heights of $1.4 trillion+ and clocks in at only 4.0% of GDP, close to a reasonable level.  In order to keep the debt to GDP ratio constant, the deficit can be as high as the inflation rate plus the rate of economic growth.  If one assumes modest 2% inflation and 2% GDP growth, then a 4% deficit will essentially keep debt flat in real terms.

Unfortunately, the math above only works if you never have a recession.  Recessions cause huge spikes in spending and decreases in revenues that shock the system.  In order to pay for these approximately once per decade shocks, in the good years, governments need to be running deficits of a lot less than 4%, ideally budgets would be balanced or even slightly in surplus.

The brief modern history here is that the US exited World War 2 with major debt from war obligations, with debt to GDP running as high as 120%.  We steadily "paid down" this debt, no so much through absolute reduction but though inflation and economic growth and by the end of the Carter administration, debt had fallen to 35% of GDP.  The next 12 years of Reagan and Bush (although H.W. did eventually agree to tax increases) saw major increases in defense spending, no cuts to social spending and large tax decreases, all of which, combined with the 90-91 recession, spiked debt to almost 70% of GDP.  The Clinton administration saw tax increases (his idea) and large cuts in defense (his idea) and social spending (Newt Gingrich's idea) which combined for budget surpluses and took debt down to 55% of GDP.

Then W. Bush took over as President and immediately slashed taxes, instituted prescription drug benefits for Medicare and ramped up defense spending in the build-up to wars in Afgahnistan and Iraq.  Debt was already up to over 70% of GDP before the recession hit and spiked to over 80% of GDP by the time Bush left office as massive outlays for bank bailouts and social benefits hit the federal coffers as the recession hit.

The first year of the Obama administration saw continued large outlays for the bailouts coupled with a large stimulus bill that spiked the debt by almost 10% in a single year.  Now the debt has stabilized right around 100% of GDP.

We really need to get back to about 50% of GDP to be able to absorb comfortably the next recession, since debt levels over 100% of GDP are reaching towards the saturation point where credit downgrades and loss of investor interest cause a spike in interest rates.  And a 1% interest rate increase on a 100% of GDP debt increases the deficit by 1% of GDP, meaning that we are very susceptible to interest rate risk if rates rise off of their current historic lows.

This deal won't accomplish any of that - it doesn't deal with tax reform, entitlement reform or defense spending reform.  But it does give the markets certainty, prevents another government shutdown in the near term and at least maintains debts and deficit at a stable level.

It is also significant in that conservatives agreed to new sources of revenue.  An increase in the airline ticketing fee is effectively a tax, since it is a direct charge to you as a consumer when you purchase an airline ticket.  Calling it a fee and not a tax is politically expedient, but the effect is the same - airline consumers pay more to the government.

The deal passed overwhelmingly in the conservative-dominated House, by a roll call vote of 332-94 with 73% of Republicans and 84% of Democrats backing passage.  It seems likely to pass the Senate, although, oddly, Republican opposition in the Senate seems a lot stronger than in the House and the vote next week may be much closer than the House vote.

For Republicans, this deal provides political cover to focus the debate on Obamacare, where they perceive themselves to have a big advantage given the struggles with the website and anger over policy cancellations.  For Democrats, they get a higher spending level and clear the legislative agenda to discuss other items that are non-budgetary, such as immigration reform, where they perceive they have a public opinion advantage.

This deal was expedient bipartisanship, but welcome bipartisanship nonetheless.

Obamacare Enrollment Improves Some
Obamacare enrollment increased dramatically in November, with the total now enrolled nationally reaching 365,000 by the end of the month, up from under 30,000 in October.

The basic benchmark of success is 7 million enrollments by the time open enrollment ends on April 1st.  Clearly, enrollment will not happen evenly across the months and will ramp up as the deadline gets closer.  Even so, October was clearly a dramatic failure.  The November numbers are less clear.  On a straightline basis, if every other month (December, January, February, March) only saw the same level of enrollment as November, enrollment would reach less than 2 million.  But, as I said, that is not the likely scenario.  It is still TBD to me if the administration comes close to its goal.

An additional 803,000 people have qualified for expansions in Medicaid and SCHIP, another key element of the law's expanded access.

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