by Michael Knox

The US government has shut down on 17 previous occasions since 1976. Fifteen of these shutdowns were by a Democratic majority in the House of Representatives. Two of these shutdowns were by a Republican majority in the House of Representatives. If shutdowns are caused by extremists, then historically the Democrats have a better record of extremism. Five of the shutdowns occurred when the Democratic Party shut down its own President. That was President Jimmy Carter.

Of the 17 shutdowns, six began at the same time as the current shutdown. These shutdowns commenced on September 30. The longest of these shutdowns was 18 days. The median length of the shutdowns was 10.5 days. In the current case, the shutdown so far has been in process for 15 days. The parties began to negotiate after 10 days. Since it is widely believed that the US government will default after 17 October, then this shutdown must end as one of the longest.



The Real Deadline
Our understanding is that the US government will not default on 17 October. In a report released on 25 September, the non-partisan Congressional Budget Office (CBO) suggests that the government can continue until a time “sometime between 22 October and the end of the month”. This suggests there are five additional days that the government can continue without default after the 17th. Still, legislators appear firmly fixed on the 17 October deadline.

How will it end?

We think that the process will be very similar to the process of ending the “fiscal cliff” in December and early January. The normal process by which the legislature is supposed to operate is that bills begin in the House of  Representatives. When they are passed by the House of Representatives, they then rise to the Senate. When passed by the Senate they then rise to the President. If the President does not agree with the bill, then he may veto it. Only by a two thirds majority of both the Senate and the House of Representatives can the veto be overturned.

This means that for legislation to become law both the House of Representatives and the President must agree. The House of Representatives and the President most certainly did not agree in December 2012 on the legislation to end the “fiscal cliff”. What then happened was that the job of finding a compromise bill was provided to the Senate.

The Senate bill was then provided to the House of Representatives at the very last moment. This bill was then too late for the House of Representatives to oppose it. The bill was then passed by an open vote of all of the members. Even though a majority of Republicans voted against the bill, the combination of the Democrats plus a few Republicans was enough to provide a majority in the House of Representatives.

Many Republicans felt humiliated by the process. Nevertheless, President Obama felt that he had discovered a technique for passing unpopular legislation through the House of Representatives.

The Presidents approach seems to be similar this time. Last week when the House of Republican leaders proposed to extend the debt limit, the President refused to negotiate with them. Instead, the problem of finding a compromise bill was provided to the Senate. The idea seems to have been that this compromise bill would be passed by the Senate and provided to the House of Representatives when it would be too late to do anything about it.

Our view is that such a Senate bill will be provided for the House of Representatives on this occasion on either the 17 or 18 of October. Again, the objective will be to pass the bill by an open vote of all members. The President’s expectation would be that a small number of Republicans, together with the Democrats can get the legislation through.

The likely agreement

Our understanding is that the Senate bill will provide funding for the government through to the 15th of January. The debt limit will be extended until the 7th of February.

Negotiators from both the House of Representatives and the Senate would need to reach an agreement on a detailed tax and spending program for the next decade. This agreement would need to be reached by the 13th of December.

This negotiation between both the House of Representatives and the Senate would be the real heavy lifting that would result from the political process that we have seen in action so far. The problem that both the House and the Senate have to deal with can be glimpsed in Chart 1. This Chart shows the most recent IMF estimates for the US general government expenditure from 2013 to 2020. They also show the IMF estimates of US general government revenue from 2013 to 2020. In both cases they also show what the history of those numbers is beginning in 2000.

The long term problem

Back in 2001 the US budget was pretty much in balance. US government revenue and US government expenditure were both 33% of GDP. Even in 2007, the numbers were that US government revenue was just below 33% of GDP although expenditure had risen to 35.5% of GDP. There was a budget deficit but it was a small one.

The coming of the global financial crisis caused government spending to blow out to over 42% of GDP while at the same time revenue fell below 30% of GDP. This generated the biggest budget deficit since the 1940’s. The estimates tell us that in calendar 2014, revenue will have recovered back to 33% of GDP, the same level that it was in 2001.

Spending will have declined to 37% of GDP. This is still 4% higher than in 2001. This is the problem. The higher level of spending is because of Obamacare. Obamacare really is an important budget issue. The arguing about it is not just ideology.

In the long term the budget has to be brought back to balance. This must be done either by reducing spending or by increasing revenue. President Obama’s preference so far has always been to increase revenue. This is necessary to fund Obamacare.

The negotiation between the House and Senate that will take place after the current fiscal crisis is resolved has to find ways of solving this problem.

Members of the House Budget Committee headed by Republican Representative Paul Ryan, suggest that the reduction of long term entitlements for healthcare under Medicare and Medicaid (these programs are different in the US than Australia) must be part of the solution. It is suggested that indexing entitlements by the GDP deflator rather than the headline CPI will be part of the solution. Means testing of entitlements will also be part of the solution. In this way the growth rate of long term health care spending can be reduced.

Conclusion

We think that sometime between October 17 and October 22 the House of Representatives will pass a Senate bill. Our understanding is that the Senate bill will provide funding for the government through to the 15th of January. The debt limit will be extended until the 7th of February.

Negotiators from both the House of Representatives and the Senate would need to reach an agreement on a detailed tax and spending program for the next decade. This agreement would need to be reached by the 13th of December. Only when this agreement is reached can the real task of mending the US budget begin.