Let’s get right to it.
Manchin and Schumer Spring a $670 Billion Surprise
Senate Majority Leader Chuck Schumer (D-NY) and Sen. Joe Manchin (D-WV) announced Wednesday that they have reached a long-awaited agreement on legislation that touches upon climate change, tax revenues, drug prices, health care subsidies and inflation.
“After many months of negotiations, we have finalized legislative text that will invest approximately $300 billion in Deficit Reduction and $369.75 billion in Energy Security and Climate Change programs over the next 10 years,” the lawmakers said in a joint statement. “The investments will be fully paid for by closing tax loopholes on wealthy individuals and corporations.”
The legislation — dubbed the Inflation Reduction Act of 2022 — would provide a revenue increase of $739 billion over 10 years, and spending of $433 billion.
Revenue sources include a 15% minimum corporate income tax, providing an estimated $313 billion; a reduction in drug prices paid by the federal government ($288 billion); enhanced IRS enforcement ($124 billion); and closing a tax loophole on carried interest ($14 billion).
On the spending side, the legislation would provide $369 billion to address “energy security & climate change,” and another $64 billion to extend Obamacare subsidies.
Overall, the legislation would provide about $300 billion in deficit reduction. But there is still some uncertainty about how the proposal will play out.
“Timing & details are very much in flux,” says Chris Krueger of Cowen Research. “Schumer is submitting the bill to the Parliamentarian tonight to begin the ‘Byrd Bath.’ None of these proposals is new — they have all been central components of the fiscal Frankenstein menu for over a year, so in theory the procedural wheels could turn quickly.”
The bottom line: After many, many, many month of fumbling and frustration, Democrats may be on the verge of securing a pre-election win that’s substantially narrower than their grand initial plans but is still significant and gives them something to tout on the campaign trail.
US Debt to Reach 185% of GDP in 2052, Driven by Interest Costs: CBO
The U.S. budget deficit is set to shrink dramatically this year as pandemic stimulus spending wanes and revenues surge — but the federal budget gap is projected to begin rising again quickly, driven by large increases in interest costs, the Congressional Budget Office said Wednesday in its latest long-term outlook.
While the budget office’s report shows somewhat smaller deficits and debt than previously forecast, it warns that the fiscal outlook remains challenging. Here’s an overview.
Deficits set to drop, then climb again: The deficit for fiscal year 2022 is estimated to be 3.9% of gross domestic product, much narrower than in the pandemic-plagued previous two years and 0.4 percentage points smaller than the budget office projected last year. In CBO’s latest projections, the deficit will drop to 3.7% of GDP in 2023 before rising again. Deficits from 2023 to 2031 are projected to average 4.9% of the economy, 0.5 percentage points larger than in last year’s projections. And further out, from 2043 through 2052, deficits are projected to average 10% of GDP, or about three times the average over the past 50 years. By 2052, the deficit is projected to reach 11.1% of GDP.
Even with that projected growth, long-term deficits in the latest projections are smaller than projected last year, averaging 8.4% of GDP from 2032 through 2051, down 1.3 percentage points from last year’s forecast.
Spending drops, but only temporarily: Federal spending this year is projected to total 23.5% of GDP, less than last year, and is expected to decline over the next couple of years as pandemic spending diminishes. But outlays then grow, climbing to 30.2% of GDP in 2052. Federal spending is expected to average 29% of GDP from 2043 through 2052, up from a projected 25% average for the next ten years. “Rising interest costs and growth in spending on the major health care programs and Social Security—driven by the aging of the population and growth in health care costs per person— boost federal outlays significantly over the 2025–2052 period,” the CBO report says.
Revenues surge this year, but not long-term: Revenues for 2022 are projected to rise to 19.6% of GDP, which CBO calls “one of the highest levels ever recorded.” But revenues aren’t expected to keep pace with projected spending growth, rising only incrementally from an average of 18% of GDP from 2022-2032 to an average of 19% of GDP from 2043 through 2052.
Interest costs are rising rapidly: The CBO estimates that net interest outlays will more than quadruple, rising from 1.6% of GDP this year to 7.2% in 2052. The average interest rate on federal debt is projected to climb from 1.8% in 2022 to 3.1% in 2032 and 4.2% in 2052. “A larger amount of debt makes the United States’ fiscal position more vulnerable to an increase in interest rates than it would be if the amount was smaller,” the CBO report warns. It adds: “If net interest costs followed their projected path, they would exceed all mandatory spending other than that for the major health care programs and Social Security by 2027, discretionary spending by 2047, and spending on Social Security by 2049.”
Debt set to soar: Debt as a percentage of GDP is lower than CBO projected last year, but is still expected to rise from 98% at the end of this year to surpass its historical high by reaching 107% in 2031 and then continuing to climb to 185% by 2052. But the long-term debt projections have improved substantially compared with last year. Federal debt held by the public is now expected to reach 180% of GDP in 2051, down from 202% in last year’s outlook, with the change driven by a strong rebound from the pandemic and less projected spending for major health care programs.
Still, the outlook is based on the assumption that current tax and spending laws remain in place long-term and relies on other optimistic assumptions, meaning that the real debt path could be considerably higher.
“Debt that is high and rising as a percentage of GDP could slow economic growth, push up interest payments to foreign holders of U.S. debt, heighten the risk of a fiscal crisis, elevate the likelihood of less abrupt adverse effects, make the U.S. fiscal position more vulnerable to an increase in interest rates, and cause lawmakers to feel more constrained in their policy choices,” the CBO warns, adding that “if future paths for spending and revenues were more consistent with such paths in the past, debt in 2052 would probably be much higher than CBO projects.”
Economic and demographic challenges ahead: The CBO said that the U.S. economy will grow more slowly over the next 30 years, with nominal GDO averaging 3.9% a year compared to 4.5% over the last three decades. Part of that slowdown is driven by demographics. The report says the U.S. population will grow much more slowly than in the past — just 0.3% a year, or a third of the growth rate over the past 30 years. With lower fertility rates, CBO says population growth by 2043 will be driven entirely by immigration.
Fed Announces Second Big Rate Hike in Row
The Federal Reserve on Wednesday raised its benchmark interest rate by three-quarters of a percentage point, to a range between 2.25% and 2.5%, maintaining its aggressive stance in its effort to bring red-hot inflation under control.
The rate hike was the second unusually large increase in a row, the first time that has occurred since Paul Volcker’s war against inflation in the 1980s. “What seemed unfathomable just six months ago – a 75-basis-point rate hike by the Federal Reserve – has now happened twice in a row,” says CNN’s Nicole Goodkind.
In a statement, the Fed’s Open Market Committee said that while some economic indicators such as consumer spending have “softened” in recent months, job growth is robust and inflation remains elevated due to an ongoing imbalance in supply and demand, exacerbated by the war in Ukraine. Given those conditions, the committee unanimously agreed that another large rate increase was warranted as the Fed pursues its target inflation rate of 2% over the long run.
How high will rates go? While the Fed’s latest rate hike was widely expected, there is less certainty about what lies ahead. At a press conference, Fed chief Jay Powell said he expects the Fed to raise rates again in the fall, though the size of future increases will depend on the economic data, with a likely endpoint of about 3.5% by December.
In a comment that sent stocks soaring on Wall Street, Powell said he could imagine smaller rate hikes in the coming months. “As the stance of monetary policy tightens further, it likely will become appropriate to slow the pace of increases while we assess how our cumulative policy adjustments are affecting the economy and inflation,” Powell said.
In those comments, Powell appeared to be providing “a dovish offset to the neo-hawkish statement” about how high rates might go, economist Joseph Brusuelas of the consulting firm RSM said. Investors are now pegging the September rate hike at half a percentage point.
Diane Swonk, chief economist at KPMG, said she expects to see rates continue to rise significantly. “The move to 2.25-2.5% is not enough to derail the inflation we are enduring, which means that Powell will have to prime the pump for more rate hikes in September, despite a sharp slowdown in growth,” she wrote in comments earlier Wednesday. “Our own analysis is that the Fed will have to raise rates to a 3.75% to 4% target range and that unemployment will nip at 6% before inflation cools back to the Fed’s 2% target.”
No recession, for now: Powell reiterated that the Fed is aiming for a soft landing, in which growth eases without going negative. He also said he doesn’t think the U.S. economy is currently in a recession, regardless of what’s announced in Thursday’s preliminary GDP report for the second quarter.
“While many are worried that the economy is verging on recession, Fed officials see the glass as half full, with the strong labor market allowing the economy to withstand rapid monetary tightening,” said Bloomberg economists Anna Wong, Yelena Shulyatyeva, Andrew Husby and Eliza Winger. At the same time, though, the economists warned that they see “little chance that the Fed will pause its rate hikes later this year, as markets currently expect.”
Other analysts agree with this less optimistic assessment of the outlook for next year. “We think a soft landing is unlikely,” economists at BlackRock said in a note. “Central banks today face sharp trade-offs between growth and inflation. We expect the Fed to change course only next year, when the economic effects of rate rises become clear.”
Stay tuned: Whatever course the economy takes in the coming months, the Fed on Wednesday appears to have achieved its goal of reassuring firms and investors about the state of the economy, while leaving itself plenty of room for maneuvering in the future, says economist Paul Krugman. “The Fed's actions and words today were sublimely boring, and I mean that in the best way,” he wrote. “No surprise on policy, no future commitments that will hinder its ability to ‘adjust the stance of monetary policy as appropriate.’ The next meeting may be more interesting.”
Quote of the Day
“When my predecessor got Covid, he had to get helicoptered to Walter Reed Medical Center. He was severely ill. Thankfully, he recovered. When I got COVID, I worked from upstairs of the White House, in the offices upstairs for that five-day period. The difference is vaccinations, of course, but also three new tools free to all and widely available. You don’t need to be a president to get these tools used for your defense. In fact, the same booster shots, the same at-home test, the same treatment that I got is available to you. … And to my friends in Congress, let’s keep investing in these tools — vaccinations, treatments, tests and more — so we can help making them available to the American people on a permanent basis.”
– President Joe Biden, speaking Wednesday from the White House Rose Garden after testing negative for Covid-19. Biden had tested positive last Thursday and experienced what the White House called mild symptoms. Additional pandemic funding has been stalled in Congress for months.
- Manchin Says He Has Reached Deal With Democrats on Economy, Climate Bill – Washington Post
- US Budget Deficit to Hit Lowest Since 2018 This Year, CBO Says – Bloomberg
- Fed Makes History With Second Massive Rate Hike in as Many Months – CNN
- White House Braces for Grim News on Economy– Politico
- The 8 Economists Who Decide if the U.S. Is in a Recession – Washington Post
- Senate Approves $280 Billion Bill to Boost U.S. Science, Chip Production – Wall Street Journal
- Navy Fleet Plan Needs 3-5% Annual Budget Increases for the Next Two Decades – Defense One
Views and Analysis
- Do You Think the Fed Hasn’t Done Enough? Think Again – Nir Kaissir, Bloomberg
- Is the U.S. Economy Growing or Not? – Peter Coy, New York Times
- The Chips Bill Means the Era of Hands-Off Government Is Over – E.J. Dionne Jr., Washington Post
- The Chips Act Has Only Gotten Better. Now It’s the House’s Turn to Act – Washington Post Editorial Board
- Big Business Loves Government Spending – Harold Meyerson, American Prospect
- Voters Already Believe We’re in Recession – David Winston, Roll Call
- On My 100th Birthday, Reflections on Archie Bunker and Donald Trump – Norman Lear, New York Times