The US will likely reach a debt limit deal to avert default before Treasury’s X date. Navigating the political fault lines will be challenging, but doable.
By: Hunter Hammond
May 23, 2023 — Capstone assigns a 90% probability that Democrats and Republicans will reach a debt limit deal and avoid breaching the debt ceiling “X date.”
While we believe there is enough time to agree on a debt limit solution in the coming days, it also is possible that negotiators need more time, resulting in a short-term debt ceiling extension of days to as long as two weeks.
Of the remaining 10%, we believe there is a 9% probability that, having breached the X date, President Biden will take unilateral action, such as invoking the 14th Amendment, prioritizing Treasury payments, minting a trillion-dollar coin, or issuing high-interest bonds, to avoid default.
We believe the probability of default—essentially a debt limit breach with no action taken to avoid missed bond payments—is only 1%.
At the end of April, Capstone made three predictions:
- House Republicans will likely pass their recently introduced debt limit bill, the Limit, Save, Grow Act (LSGA).
- The Democratic leadership’s position—to not negotiate on the debt limit and Republicans’ push to pass a clean debt limit increase—will likely evolve.
- A bipartisan agreement in the Senate on a “clean-ish” debt ceiling increase will likely emerge this summer.
Predictions one and two were right. House Republicans, led by Speaker Kevin McCarthy (R-CA), passed the LSGA, and Democrats, led by President Biden, were forced to negotiate. However, our third prediction has been wrong so far. Moderate Senate dealmakers are staying on the sidelines to avoid undercutting negotiations between President Biden and Speaker McCarthy.
Those negotiations are ongoing, and Capstone believes the White House and Speaker McCarthy will reach an agreement on a deal to lift the debt ceiling and avoid default soon. Negotiations have progressed from staff-only sessions to meetings between the president and the speaker, the frequency and sentiment of which demonstrate progress.
Political Breakdown of a Likely Deal
We believe it is imperative to focus now on the politics of a potential deal. Any deal will need the support of most House Republicans and likely more than a simple majority. With 150‒180 House Republicans on board, Speaker McCarthy can feel somewhat secure that avoiding a default will not cost him the speakership. That means House Democrats will have to supply the remaining 40‒70 votes. The same deal also must get the support of 60 senators, likely on the order of 35‒50 Democrats and 10‒25 Republicans. The question is, however, what type of deal can carry that many House Republican votes without endangering Senate passage?
To start, we have far more confidence in the president’s ability to whip the necessary votes from Democrats in both chambers and Senate Minority Leader Mitch McConnell’s (R-KY) ability to whip Republican votes in the Senate than the speaker’s ability to whip House votes. Despite his impressive passage of the LSGA, the risk of losing the confidence of his caucus, and thus his speakership, makes Speaker McCarthy’s job inherently tougher than any of the other principals in the room.
As such, we believe a debt limit deal can tilt right without threatening passage from Democrats. However, the deal cannot be seen by Democrats as a capitulation or political defeat.
In our opinion, a deal with sufficient votes, therefore, will have to be able to generate savings considerable enough for Republicans to support but not be painful enough to jeopardize Democratic votes even under pressure from the president and his top lieutenants. In our opinion, savings will come from a deal on the budget. The Congressional Budget Office (CBO) provides a 10-year baseline projection of revenues, outlays, and the deficit. As such, even modest changes today will greatly affect the 10-year savings scored by the CBO. The LSGA would save roughly $4.8 trillion, while holding spending flat at existing levels would save roughly $2.6 trillion.
Right now, there is agreement on rescinding some $50 billion to $60 billion in unspent COVID-19 pandemic funding, while there is still real disagreement on work requirements for safety-net programs such as Temporary Assistance for Needy Families (TANF), Supplemental Nutrition Assistance Program (SNAP), and Medicaid. There also appears to be a growing consensus on the importance of enacting permitting reform to facilitate the construction of US energy infrastructure, though we remain skeptical that a deal on broad and bipartisan reforms will materialize in time to be considered within the debt ceiling debate. Still, we believe an agreement on topline permitting priorities between Speaker McCarthy and the White House—or neutral, noncontroversial changes to environmental permitting timelines for all energy projects—will likely be necessary to sway Republicans for a near-term deal.
In the coming months, we anticipate that a broad permitting reform proposal will be introduced by Senators Joe Manchin (D-WV), Shelley Moore Capito (D-WV), John Barrasso (R-WY), and Tom Carper (D-DE) ahead of the Senate’s summer recess. We expect the bill to build off the proposal that Sen. Manchin reintroduced earlier this year, incorporating National Environmental Policy Act (NEPA) and judicial changes to accelerate permitting timelines, considerations for transmission siting, as well as key Republican priority items such as onshore and offshore oil and gas leasing timelines.
Meanwhile, reports indicate that other proposals are no longer on the table, including closing the carried interest loophole, repealing key Inflation Reduction Act (IRA) tax credits and other signature IRA provisions, and enacting regulatory reform through the Regulations from the Executive in Need of Scrutiny (REINS) Act.
That leaves the real question of the budget. The LSGA would reduce FY24 discretionary spending to FY23 levels with a 1% increase per year for 10 years. The White House offered, and Republicans rejected, a deal to freeze FY24 discretionary spending at FY23 levels with a 1% increase for FY25. We expect negotiations to focus on how deep cuts should be in FY24, which side (defense, non-defense, or both) absorbs the cuts, by how much FY24 levels should be increased going forward, and for how long. Democrats want any budget deal to extend only for as long as the debt ceiling is lifted. Republicans do not want cuts to affect defense spending.
Ultimately, we believe there is a deal to be had on the budget both from real spending changes and budget gimmicks such as attributing rescinded COVID-19 funding toward spending cuts or adjusting levels with accounting adjustments.
What to Watch for Next
With the debt limit X date approaching soon—as early as June 1st but potentially June 7th or 8th—we will be watching for a deal to emerge in the next few days (May 24rd‒26th). While there are many procedural hurdles to processing any bill swiftly in Congress, almost all rules can be waived if necessary. Weekends, late nights, missed flights, and the potential economic crisis resulting from default are powerful catalysts in Congress. We believe if there is a deal that has the votes, procedural constraints will not hinder passage before the X date.
If a deal does not emerge soon, but negotiators are close, we believe Congress will pass a short-term extension, buying negotiators a couple of days to as long as two weeks to finalize the package and vote on it. Neither side appears willing to offer a multi-month extension at this point. Finally, if we are wrong and talks do break down, we will enter a new phase of this debate. Watch for calls from Republicans to prioritize payments and from Democrats for the president to deploy unilateral measures such as invoking the 14th Amendment, minting a trillion-dollar coin, or issuing high-interest bonds. We do not believe we will get to a point where such actions are necessary, but faced with the choice between default and other options, we believe the president will choose other options.