Goldman's Jan Hatzius believes the odds of a government shutdown next week are fairly low, but rise to around one in three if the debate extends into May. A shutdown at the start of the next fiscal year, in October, is a greater risk in their view.
- President Trump has continued to focus on “reciprocity” in trade but has clearly changed course on his prior view that economic relations with other countries should not be subordinated to geopolitical concerns. In light of the range of geopolitical concerns at the moment, this suggests that trade policy changes may be more incremental in the near term.
- Despite clear indications that they would postpone further consideration of health legislation, Republican leaders appear intent on trying to pass health legislation one more time. House passage of a broad ACA replacement bill seems unlikely, and we expect that the House will either pass a much narrower bill or will ultimately move on to other issues by June.
- The renewed focus on health care has once again delayed tax reform efforts, however. We still believe tax legislation is likely to become law, but continued delays suggest that enactment is likely to slip to early 2018.
- Strong Democratic performance in recent special elections for the House of Representatives has generated discussion of more significant than expected Republican losses in the 2018 midterm election. While special elections do have some predictive power, a simple analysis of special elections back to 1970 shows a fairly weak relationship between special elections and the following midterm election results.
Q: How much of a risk is a government shutdown at the end of next week?
A: There is a risk of a partial federal shutdown, but we believe the risk is fairly low next week, rising slightly if the debate is pushed into May, and rising further still later this year. Congressional appropriations expire April 28, and Congress will need to reach an agreement on a new spending bill by that time to avoid a partial shutdown of the federal government. Even if all Republicans support the bill passage is not guaranteed, since it is likely to need 60 votes in the Senate, or at least 8 Democrats in light of the 52-seat Republican majority. In the House, the bill is likely to need some Democratic support as well, since some fiscal conservatives are likely to vote against it.
In our view, there is only a one in four chance of a shutdown on April 29, because it appears likely that if an agreement is not in place by that time, Congress will pass a “clean” short-term extension that avoids controversial issues. The cumulative probability of a shutdown by May is somewhat higher in our view—around one in three—since lawmakers might eventually demand a longer extension through the end of the fiscal year, which would require resolution of any controversial items.
Thus far, Republican leaders appear to be trying to keep controversial items out of the bill, in the hope of avoiding a shutdown. New funding for President Trump’s proposed border wall or provisions that would strip federal funding for so-called “sanctuary cities” have been raised as possibilities but at this point seem unlikely to be included. A recent push by congressional Democrats to include funding for the cost-sharing subsidies under the Affordable Care Act (ACA) poses greater risk; if Democrats insist on its inclusion, it could be difficult to secure broad Republican support. Our expectation is that the White House might need to commit to not unilaterally withdraw funding for these subsidies, reversing President Trump’s recent suggestion he might do so.
The risk of a government shutdown appears more serious at the end of the fiscal year (September 30), for two reasons.
First, it is likely to intersect with the debt limit, which we expect to become a constraint on Treasury borrowing by October.
Second, at that point Congress will need to make more significant decisions regarding spending levels.
While congressional Republicans and the White House might be willing to accept lower defense spending and higher domestic spending than they would like for the remainder of the current fiscal year, they are much less likely to accept spending bills for the fiscal year that starts October 1 unless they increase defense spending and reduce non-defense spending, and fund some of the President’s other initiatives such as increased border enforcement.
Q: What have the last few weeks demonstrated regarding the Trump Administration’s trade policy?
President Trump has continued to emphasize reciprocity, but has downplayed the notion that foreign policy and trade policy should be delinked. Coming into the year, there appeared to be two driving principles behind the Trump Administration’s trade policy: reciprocity and a separation of strategic from economic interests in foreign policy. Reciprocity continues to be a core principle of the President’s trade agenda, judging from recent comments in support of a “reciprocal tax” on imports, which would apparently apply the same tariff on a particular good from a particular country as that country applies on the US good.
By contrast, the President seems to have explicitly reversed his previously stated view that economic considerations should not be subordinate to geopolitical or strategic considerations in foreign policy. For example, in its recent report to Congress on the Administration’s key principles on trade policy, the Office of the US Trade Representative, part of the White House, said that it “reject[s] the notion that the United States should, for putative geopolitical advantage, turn a blind eye to unfair trade practices.” However, President Trump appears to be making an exception for China for the moment, stating “we have tremendous trade deficits with everybody, but the big one is with China…and I told them, ‘You want to make a great deal?’ Solve the problem in North Korea. That’s worth having deficits. And that’s worth having not as good a trade deal as I would normally be able to make.”
Where does this leave trade policy overall? For now, it suggests that the Administration is still likely to pursue some incremental restrictions on certain products but that major actions are unlikely in the near term. That said, this does leave some tension between the President’s stated goal of reciprocity, which would ultimately require higher tariffs and other restrictions on imports from many countries, and his view that some strategic goals justify less favorable trade terms for the US.
Q: Is health legislation really coming back onto the legislative agenda?
We expect some type of health legislation to become law eventually, but we’re skeptical a revised health bill can become law in the near term, for three reasons.
First, despite a renewed interest among Republican leaders in addressing the issue—President Trump said last week that he once again expects to address the health bill before the tax bill, if it can be passed quickly—not much has changed; the fundamental disagreements that sank the bill in late March have not been resolved.
Second, the Senate faces different political constraints than the House and would likely have an even more difficult time passing legislation similar to what the House nearly voted on in late March.
Third, the health bill seems unlikely to produce much if any savings over the next ten years, and therefore probably cannot be used to meaningfully offset the cost of a tax cut; the most recent version of the House bill would have reduced the deficit by about $150bn over the next ten years, or enough to reduce the corporate tax rate by 1pp. It is true that it would have also reduced taxes by nearly $1 trillion over ten years, but this is relevant mainly if one assumes that without the health bill Congress would include that $1 trillion in tax cuts in its tax bill instead.
In our view, the House is likely to make a final attempt at passing health legislation in mid- to late May. If this is a scaled-down bill that addresses only certain less popular aspects of the Affordable Care Act (ACA), like the individual mandate, it might pass the House and Senate and become law. Alternatively, if it is similar to the American Health Care Act (AHCA) that the House was scheduled to vote on in late March, we would expect the bill to once again fail to pass.
Q: Where does all of this leave tax reform?
Not much further along than where it was a few months ago. We recently wrote that our view continues to be that tax legislation is likely to become law, but that it is more likely to be a tax cut with limited elements of reform, namely a 25% corporate rate with provisions allowing for low-tax repatriation of foreign profits, incremental base broadening, and no border adjusted tax. However, the timing does appear to be slipping once again; if the legislative focus remains on health legislation through May, a vote on tax reform at the committee level might not occur in the House until July, which could make final enactment of tax legislation before year-end challenging. At this point, we expect that enactment is more likely in Q1 2018 than Q4 2017.
Q: What do recent special elections tell us about the 2018 midterm election outlook?
Not much that is not already known. Special elections for the House of Representatives last week (April 11) and again yesterday (April 18) have resulted in a stronger Democratic showing than would normally be expected given the political leanings of the respective districts. In Kansas, the Democratic candidate trailed by only 7 points in a district that went to President Trump by 27 points last November. Preliminary results in the Georgia race show Democratic candidates winning a cumulative 49% of the vote and Republicans 51% (there were several candidates of each party in the preliminary round, with a final two-way race scheduled for June 20), slightly better than President Trump’s 1-point win there in 2016.
There appears to be a loose positive relationship between the seats a party gains in special elections and that party’s results in the following midterm election, as shown in the exhibit below. The horizontal axis shows the gain or loss of seats by the president’s party, as a share of all seats that changed control as a result of special elections. The vertical axis shows the net change in seats resulting from the following midterm election (special elections following presidential election years are excluded).
The relationship suggests that the party controlling the White House typically loses around 19 seats in midterm elections, all else equal, with a loss of an another 14 seats if the president’s party consistently loses special elections in the run-up to the midterm (Democrats would need to win 24 seats to win the House majority in the 2018 midterm election). While these results are not statistically significant, a longer sample analyzed by Smith and Brunell back to 1900 show a stronger relationship. Regardless, we note that special elections have sent false signals in the recent past, such as the run-up to the 2010 midterm election, when Democrats won seven of nine special elections in the House but lost 63 seats in the general election in November.
Additional special elections are expected in May in Montana and in June in California and South Carolina, and again in Georgia. These are likely to be watched closely as a barometer of political sentiment ahead of the 2018 midterm election. If Democrats outperform in these races, it could increase the motivation among congressional Republicans and the White House to move away from controversial issues like health care and to focus more on tangible legislative achievements like tax legislation or an infrastructure program.
Source: Goldman Sachs
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