By Hunter Hammond and Josh Price, Capstone analysts

Capstone believes the debt limit debate will enter a new stage of the Congressional game of chicken in the coming weeks, and the fireworks have just begun. Although the House has gotten the bulk of the early attention, we believe the Senate is where the key drama will play out. With the specter of a potential default looming as soon as summer we put forward three predictions:

1. House Republicans will likely pass their recently introduced debt limit bill, the “Limit, Save, Grow Act.”
2. The Democratic leadership’s position to not negotiate on the debt limit and that Republicans must pass a clean debt limit increase will likely evolve.
3. A bipartisan agreement in the Senate on a “clean-ish” debt ceiling increase will likely emerge this summer.

If we are right, we believe real policy and a real solution to the debt limit impasse will begin to emerge in May. As such, investors should prepare for a larger policy debate in the Senate—a debate not strictly limited to increasing the debt limit. Using history as a guide, of the 61 debt ceiling measures enacted since 1978, just under half (27, or 47%) of these measures were standalone bills limited to raising the debt ceiling. Over the past 10 years, only 33% of measures enacted (3 of 9) to raise the debt ceiling were standalone bills, with the rest containing ancillary policy provisions.

Investors should prepare for a larger policy debate in the Senate—a debate not strictly limited to increasing the debt limit.

Prediction 1: Capstone believes House Republicans will pass their recently introduced debt limit bill, the “Limit, Save, Grow Act.”

Speaker Kevin McCarthy (R-CA) recently introduced the Limit, Save, Grow Act of 2023 (LSGA). The 320-page bill includes a plethora of Republican policy priorities, including:

• Cap fiscal year (FY) 2024 discretionary spending at FY2022 levels, a roughly $130B cut,
• Allow future discretionary spending to grow at only 1%,
• Rescind $50-60B in unspent COVID-19 funds,
• Claw back $71B in funds for the Internal Revenue Service,
• Repeal clean energy tax credits from the Inflation Reduction Act,
• Stop President Biden’s student debt forgiveness plan,
• Impose additional work requirements on safety-net programs such as Medicaid,
• Limit executive power through the Regulations from the Executive In Need of Scrutiny (REINS) Act, and
• Reform energy and permitting policy through the Lower Energy Costs Act (HR 1).
• In return, the LSGA would lift the debt limit through March 31, 2024 or by $1.5 trillion, whichever occurs first.

Speaker McCarthy intends to pass the LSGA next week, and while this will be a monumental lift, the alternative—should the bill fail—is a significant loss of negotiating leverage with Democrats. We believe House Republicans know this and will ultimately get on board with a bill filled largely with policies supported by the majority of conference members.

Speaker McCarthy needs 218 votes and can afford to lose no more than four Republicans on the vote. Democrats will offer no support in the House.

We will be watching closely for Republicans on both the far right and moderates for signs of support or opposition. Far right members—Reps. Andy Biggs (R-AZ) Matt Gaetz (R-FL), Eric Burlison (R-MO), Tim Burchett (R-TN), Anna Paulina Luna (R-FL)—likely want steeper cuts or are opposed to raising the debt limit at all. While repeal of the entire Inflation Reduction Act was not included in the LSGA, a concession by the Freedom Caucus, we expect those same members will want stricter work requirements, a position at odds with moderate members.

Meanwhile, moderate members and  those in districts won by President Biden in 2020—Reps. Brian Fitzpatrick (R-PA), Tony Gonzales (R-TX), Nancy Mace (R-SC), Marc Molinaro (R-NY)—are likely worried about the politics of eliminating tax credits and increasing work requirements. We’ve also seen reticence from Midwest House Republicans over voting on the record to eliminate the IRA’s biofuel tax credits, even though the bill’s IRA provisions will not go anywhere in the Senate. We tend to think that the moderates will get on board when push comes to shove to allow negotiations to begin in earnest. 

Prediction 2: Capstone believes the Democratic leadership’s position to not negotiate on debt limit and that Republicans must pass a clean debt limit increase will likely evolve.

Since Representative McCarthy became Speaker McCarthy, Democratic leadership—President Biden, Senate Majority Leader Chuck Schumer (D-NY), and House Minority Leader Hakeem Jeffries (D-NY)—have been adamant that they will not negotiate over the debt limit, insisting that Republicans pass a clean increase.

After Speaker McCarthy released the LSGA, Democrats doubled down on their position. Should House Republicans pass the LSGA, we believe this position will become untenable. Already, some Democrats in Congress are calling for a restart of negotiations. Those calls will likely grow should Republicans pass their bill. Additionally, as recent history shows, the odds favor a negotiated bill with included issues outside of the debt ceiling increase.

To be clear, even if negotiations resume, the LSGA is dead on arrival in the Senate. We cannot see a world where Democrats agree to far stricter work requirements, repeal any of the clean energy tax credits from the Inflation Reduction Act (their signature legislative victory), agree to the extensive permitting reform provisions in the LGSA or restrict discretionary spending to the levels proposed by Republicans.

As the clock ticks closer to the “X date”, a restart in negotiations would be positive for finding a solution; however, the chasm between the House Republican plan and the Democrats’ call for a clean debt limit increase is very wide. This presents an opportunity for the Senate.

Prediction 3: Capstone believes a bipartisan agreement in the Senate on a “clean-ish” debt ceiling increase will likely emerge this summer.

To date, the Senate has been largely absent from the debt limit debate. With the exception of Sen. Joe Manchin (D-WV), Senate Democrats have towed the party line, insisting on a clean increase. Meanwhile, with Senate Minority Leader Mitch McConnell (R-KY) out with a concussion, Senate Republicans have largely left debt limit strategy to the House. We believe this is likely to change for several reasons:

1. Senate moderates have been surprisingly successful in starting and passing bipartisan legislation in recent years. From the gun violence to infrastructure to semiconductors to marriage, a group of bipartisan Senators have managed to form a block and get legislation passed. We believe these same Senators will want to find a solution to the debt limit impasse.
2. The Senate has historically been the chamber where debt limit deals are struck, and the players are not new. President Biden and Sen. McConnell have a long history of working together, including on debt limit debates.
3. The LSGA includes tax and spend items, giving the Senate a revenue vehicle to address tax policy. For Democrats, there will likely be interest in proposing tax increases to reduce deficits such as those in President Biden’s FY2024 budget. For Republicans, there will likely be interest in addressing expired Tax Cuts and Jobs Act tax provisions including bonus depreciation and the research and development tax credit. 
4. Speaker McCarthy has recently taken to goading the Senate into action by critiquing the chamber for passing resolutions on maple syrup and college basketball. While these jabs are unlikely to change Sen. Schumer’s strategy, it will likely inspire Senators to move their policy priorities into the debt limit spotlight.

Investors and companies should pay attention when the Senate begins to engage on the debt limit debate.

Investors and companies should pay attention when the Senate begins to engage on the debt limit debate. While the LSGA is dead on arrival in the Senate, real policy will likely be on the table.

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