Manchin and Schumer Spring a $670 Billion Surprise

Joe Manchin
Reuters
By Yuval Rosenberg

A busy news day, as Senate Democrats announced a
surprising $670 billion deal for climate programs and deficit
reduction, the Federal Reserve jacked up interest rates again and
the Congressional Budget Office issued its latest long-term
outlook. Oh, and the Senate passed the $280 billion semiconductor
and science bill, which is also set to pass the House.

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.

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