Highlights:
Introduction
Unquestionably, the most significant fiscal policy challenge confronting the next Congress and the incoming Trump administration is the pending expiration of the Tax Cuts and Jobs Act (TCJA). But before policymakers grapple with this issue, they’ll have to confront three unavoidable fiscal policy challenges. The most immediate challenge is addressing a scheduled, across-the-board spending cut set to go into effect soon after the conclusion of the 118th Congress due to positive balances on the Statutory Pay-As-You-Go (S-PAYGO) Act scorecards. The second challenge will be dealing with a second scheduled across-the-board spending cut due to a provision of the Fiscal Responsibility Act (FRA) that established caps on discretionary spending levels for fiscal years 2024 and 2025. Lastly, the statutory debt limit, which was temporarily suspended under the FRA, will be reinstated on January 2nd and require suspension or increase at some point later in the year when Treasury exhausts its cash and borrowing authorities.
Statutory PAYGO
The Statutory Pay-As-You-Go Act was signed into law, along with a debt-limit increase, by President Obama in February of 2010. Under S-PAYGO, the average annual net revenue and direct spending effects of legislation over the 5- and 10-year periods subsequent to its enactment are estimated, averaged, and recorded by the Office of Management and Budget (OMB). Over the course of the year, OMB tallies the S-PAYGO effects of legislation, and if there is a positive balance on either the 5- or 10-year scorecard, OMB is required to order a sequestration of non-exempt funding to offset the debit on the S-PAYGO scorecard. If there is a debit on both the 5- and 10-year scorecards, as is currently the case, OMB is required to offset the larger of the two debits. Or so it goes in theory – in reality, OMB has never ordered an S-PAYGO sequester. Instead, Congress has always stepped in to wipe out or punt the sequester to the following year. At present, the scorecard shows a 10-year balance of nearly $1.7 trillion. Notably, this is entirely due to past deficit spending, such as the American Rescue Plan Act. Congress has shifted past balances forward to FY 2025 to avoid triggering a sequester.
It is important to note that even if Congress allowed the sequester to occur, most spending is exempt from sequestration. Indeed, according to the most recent estimates, there is $200.6 billion in non-exempt spending that could be sequestered. This amounts to less than 3 percent of FY2024’s spending total of $6.75 trillion. Congress is likely to erase or push these debits forward again in the lame duck session in December.
Fiscal Responsibility Act (FRA) Revised Spending Caps
In May of 2023, Congress enacted the Fiscal Responsibility Act of 2023, which provided for a suspension of the federal debt limit until January 2 of 2025. In addition, the Act includes a number of policy changes, most significantly, renewed discretionary spending caps. The essential compromise struck between the Biden administration and House Republicans was a suspension of the debt limit in exchange for renewed caps on discretionary spending for fiscal years 2024 and 2025. For FY2025, the FRA limits discretionary spending to $895 billion for defense and $711 billion for nondefense discretionary funding, for a combined spending limit of $1.606 trillion for FY2025.
While statutory spending caps can provide certainty for the appropriations process, Congress has nevertheless struggled to pass timely funding bills. At present federal agencies are operating under a continuing resolution (CR), which expires at midnight on December 20. A previous iteration of the CR would have run through March 25, but failed to pass the House. It is unlikely that Congress will enact full-year appropriations acts during the lame duck, which means that at least some federal agencies will continue to be funded under a continuing resolution. That would trigger section 102 of the FRA, which imposes lower discretionary caps if any agencies are operating under a CR as of January of the current fiscal year. As with the original (section 101) caps under the FRA, the reduced, section 102 caps are enforced through sequestration.
One wrinkle to this process is timing. If a CR is in effect in January, the reduced section 102 caps take effect. Current funding levels would exceed the reduced caps, and the overage would result in sequestration. However, this process is not enforced until April 30. If Congress completes appropriations by then, the caps revert to the higher section 101 levels, obviating the need for a sequester. This is precisely what occurred in the spring of 2024 – the section 102 caps became effective in January of 2024 but reverted back to the higher caps when Congress enacted all 12 appropriations acts in two “minibuses “in March. If Congress does not complete all 12 appropriations bills by April 30 (or otherwise change the FRA) a sequestration order will be issued.
Federal Debt Limit
The final and potentially most troublesome fiscal tripwire facing the next Congress is the reinstatement of the statutory limit on the Treasury Department’s borrowing authority. Prior to the enactment of the FRA, the Treasury Department had reached the prevailing debt limit and had to employ “extraordinary measures” to maintain liquidity. These measures, which have become routine during debt limit negotiations, are a series of accounting maneuvers that Treasury employs to continue to raise cash to pay obligations even when it has reached the debt limit. These measures are limited, and once exhausted, the federal government risks technical default and potential widespread economic harm.
Determining when Treasury will exhaust its borrowing authority is subject to significant uncertainty. First, the Treasury has built up a significant cash balance in its general account at the Federal Reserve: $836 billion as of October 29th. This provides something of a cushion, as do periodic tax payments throughout the year such as April 15. However, Federal cash flows can be highly volatile and unpredictable, making the determination of an exact “X-Date” highly uncertain. Thus, while the debt limit shot clock will start on January 2nd, it will be some time into 2025 before Congress will need to address it. The challenge is that addressing the debt limit tends to be highly contentious and again, subject to uncertain timing.
One approach to raising the debt limit is through the budget reconciliation process – which provides a filibuster-proof pathway for considering budget-related legislation such as the debt limit. In the event of a Republican sweep, this process will certainly be invoked to address tax policy. Facilitating a debt limit increase through this process could minimize disruptions to financial markets that can arise during debt limit negotiations.
Conclusion
From sequestration threats under Statutory PAYGO and the Fiscal Responsibility Act to the inevitable clash over the debt limit, each of these “fiscal stop signs” represents a critical juncture for the nation’s fiscal stability. Yet, if past behavior is any indication, Congress may once again seek temporary fixes or defer tough decisions, potentially exacerbating long-term fiscal risks. Nevertheless, while much of the fiscal policy debate is looking ahead to the tax fight, there are other significant fights to be had in the coming months.