The US budget process begins about 12 months prior to the start of the fiscal year. The President submits budget documents to Congress on the first Monday in February. The Congressional Budget Office reviews and analyses the president’s budget and produces three main reports:
- Budget and Economic Outlook report in mid-February
- Budget Options report in March
- Analysis of the President’s Budgetary Proposals in April
During this time, the House and Senate budget committees conduct hearings and publish reports for the various appropriations legislation which authorises the government to spend money. The President is required to sign the legislation for the budget to become law. If the President does not sign the legislation by the start of the fiscal year, the Federal Government can shut down. Once the President signs the bill, the budget takes effect on 1st October.
The US budget process is particularly important this year due to the change in administration and divisive state of US politics. I have just returned from Washington D.C., where I met with business leaders and economists to hear their thoughts on the new Administration’s fiscal reform; discuss the likelihood that it would pass through the budget process, and consider its impact on economic outlook.
Here is a summary of some of the challenges and issues we discussed, which you will no-doubt see played out in the media over the coming months.
President Trump’s economic priority is job creation and this places the US budget as the Administration’s top priority. The President wants to create more jobs by reforming the tax system (which he believes unfairly penalises American companies), renegotiating existing international trade agreements, shifting from multilateral to bilateral agreements (as seen by his seeking of a quick deal with the UK to demonstrate this can be done) and removing what he deems to be excessive regulation (especially that related to the Environmental Protection Agency).
Can this be achieved? Yes, but it is going to take a frustratingly long time and be a complex affair, despite the fact that there is a Republican presidency and Congress.
It seems the Administration will try to combine reform of the Affordable Care Act (ACA) and the budget under a reconciliation bill in Congress. This means that it will require only 51 votes in the Senate and the Republicans have 52 seats. If the Administration fails to get a reconciliation bill, the budget will require the support of eight Democratic Senators.
A reconciliation bill, however, requires the budget to be revenue neutral over ten or more years and this will be tricky. We discussed whether the combination of corporate and personal tax simplification and the reduction could be financed by the mooted border tax adjustment (imposing a 20% tax on imports). The effectiveness of the border tax adjustment, however, is theoretically challenged, as the US dollar is likely to appreciate, thereby offsetting any nominal relative price advantage. This would also be extremely divisive, setting American companies against each other, with importers (retailers) pitted against exporters (manufacturers), or old economy against the new economy. Without the fillip of a border tax adjustment, the only other obvious budget neutralising measure appears to be a tax on repatriated foreign capital by US companies, or expenditure cuts phased by repealing ACA.
Before an agreement is reached, the budget process is likely to be drawn out as the government will likely run out of money by April 28th. This means the debt ceiling will need to be raised. Raising the debt ceiling would allow the Democrats to delay the budgetary process as they seek to make the Republican Administration appear inept. A Government shutdown seems inevitable.
The ACA will be undone by an Executive Order, but whether it will be repealed (politically difficult to do) or replaced (challenging) is unclear. The challenge is to come up with an alternative. Repealing the ACA will cause significant job losses (I have seen estimates of 3 million).
Infrastructure spending is universally popular, but the authority to do so will not be given until 2018, simply because of the time it will take to pass the budget. This means no economic stimulus until 2019, which is when campaigning for the next presidential elections will commence – oh to be China’s President Xi with a ten-year horizon!
It seems likely, therefore, that there will be much heat and little light over the next months. This is an assessment professional economic forecasters seem to agree with, as there have the been only modest upgrades to economic growth for the next two years.
Equity markets, however, have taken a different tack by becoming ever more expensive in anticipation of corporate tax cuts and stronger economic growth. This suggests that investors have already priced-in the best possible outcome. The political reality of the difficulties of passing structural reforms may cause a re-think by investors.
If you would like to hear more about my views on the US economic outlook, I encourage you to get in touch.