Turmoil in Washington "A House Without a Rudder"

Yesterday House Speaker Kevin McCarthy was voted down as House Majority leader by just a few members of his own party and most all members of the opposing party. There are no more Norms in Washington but does the end justify the means. What has been going on in Washington for more than a decade is not sustainable and something needs to change.

The last few days in Washington has looked like a circus act. The Government is going to shut down because Congress has not approved spending for next year. Deals are made and magically the Government is open again for an additional 45 days. This would give the House more time to approve next years spending. However, if this act plays out like previous acts in Congress, 45 days will come and go, and they still will not have approved next years spending bringing us right back to extending the deadline for another 30 days. After 30 days, it’s magically the holiday season and Congress wants to go home so because they could not agree on the spending budget the way they should have, they punt and roll all the spending into one giant bill called an “Omnibus Bill” and approve it until they need to deal with it next year.

This has gone on for years and it does not matter what party controls the House it is always the same old story. One large “Omnibus bill” is approved and spending in Washington keeps on growing year after year and the annual deficit grows along with it with no accountability. The 2023 Government budget will be $1.9 to $2.5 Trillion (that is TRILLION) above the revenue the Government takes in. The average US Citizen would have to file Bankruptcy under these circumstances so why is our Government different.

The fiscal year ended last week, alarms went off both literally and figuratively, and a last-minute deal was reached to keep the government open for another forty-five days. Later in October the Treasury Department will figure out the final budget numbers for last year and we estimate the deficit will come in a little north of $1.7 trillion, or 6.5% of GDP.

In a fiscal year when unemployment averaged only 3.6%, that’s a horribly high budget deficit to run, and a sign that something is deeply wrong with US fiscal policy. Worse, this past year’s deficit was artificially and temporarily held down by the Supreme Court striking down much of President Biden’s plan to forgive student debt. Without that decision, the deficit would have been close to 8% of GDP.

The bottom line is that the US is approaching a fiscal reckoning sometime in the next few years where it will need to either reduce future spending or find more future revenue. Even tougher, this will have to happen in a geo-political backdrop where the US may have to ramp up military spending to project more power in the Pacific.

We root for spending cuts, particularly to entitlements. But, given that politicians who advocate for spending cuts using any tool they can find (debt ceiling or shutdowns) are verbally flayed by the establishment, we are not holding our breath. The establishment wants tax hikes, and that’s likely what we will get.

The good news is that we don’t think tax hikes will hit until at least 2026. Why that year? Because significant parts of the tax cuts enacted in 2017 under President Trump are set to expire at the very end of 2025. That expiration will focus the minds of politicians running for federal office in 2024, House, Senate, and President. In turn, in 2025, depending on the outcome of the election, some sort of deal will be reached about extending those tax cuts.

We think there’s about a 35% chance of a Republican sweep in 2024 (the presidency and majorities in both House and Senate). If that happens, we will likely get an extension of all the Trump tax cuts. However, unless that extension is coupled with aggressive spending cuts or entitlement reforms, it will be tough to sustain those tax cuts well beyond 2026.

We also think there is about a 20% chance of a Democratic sweep. If that happens, we’re likely to get significant across-the-board tax hikes. Policymakers will claim they are only raising income tax rates on “the rich,” but we think other kinds of tax hikes would be on the table, like higher gas taxes or maybe a carbon tax like the Clinton Administration proposed in 1993. In addition, taxes would likely go up on corporations, even though much of the burden from such a tax hike would be felt by their workers and their customers.

That leaves a 45% chance of having mixed government in 2025-26, with each party having control of at least one of the White House, the House or the Senate. In that case, expect most of the Trump tax cuts to be extended, except at upper income levels, where tax rates would likely revert to where they were under President Obama. This would be similar to the compromise that was reached for 2013, when the Bush tax cuts enacted in 2001 and 2003 were set to expire.

The one thing we know for sure is the US is on an unsustainable path. If we don’t cut spending, tax hikes are eventually on the way.

Source: Brian S. Wesbury, Chief Economist, Robert Stein, Deputy Chief Economist First Trust



Fortem Financial
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Brian Amidei, along with Partners Joseph Romano and Brett D'Orlando have also been named *2014, 2015, 2016, 2017, 2018 Five Star Wealth Managers!

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