There is an old house with a box of dynamite in the attic.
Every few years, for as long as anyone can really remember, the children of the house have brought the box downstairs and played games with its contents. The owners have never seemed very concerned—after all, so far, it has never exploded. But each generation of kids seems just a little more reckless and irresponsible than the last and it takes just one mistake…
The house is the federal government. The dynamite is the debt ceiling. And over the next few weeks, this dangerous game will, once again, be played out in Congress. In addition, even if Congress again raises or suspends the debt ceiling without incident, related decisions will impact the tax code, the extent of fiscal stimulus and the investment environment.
Starting with the dynamite, the federal debt ceiling was first established in 1917 and has been raised or suspended 57 times over the last 50 years. The most recent suspension of the debt ceiling ended on July 31 of this year, when it was set at the outstanding federal debt at that time, that is, $28.5 trillion. Since then, Treasury Secretary Janet Yellen has been using the conventional bag of accounting tricks to pay the bills, including running down the Treasury’s once considerable balance in its checking account at the Fed. (At its peak in July 2020, this amounted to almost $1.8 trillion. By last Wednesday, this had dwindled to just $201 billion.) Last week, Secretary Yellen updated Congress on the situation, warning that her ability to maneuver below the debt ceiling will likely be exhausted by mid-October. This would threaten normal government payments and potentially trigger a catastrophic default on U.S. government debt.
The obvious solution is to eliminate the debt ceiling immediately and forever. There is no evidence that this limit has slowed the growth of government debt over time and the focus on this issue diverts attention from the more relevant questions of how much the federal government should be raising in taxes and from whom, and, how much it should be spending and on what.
However, the debt ceiling has, yet again, been deployed as a political football in the last few months with Senate Minority Leader Mitch McConnell vowing that there will be no Republican votes to raise it (Source: “McConnell vows no GOP help with debt ceiling.” Politico, August 5, 2021) and House Speaker Nancy Pelosi refusing to raise it as part of the reconciliation bill which, technically, would require only Democratic votes (Source: “Pelosi says raising the debt ceiling won’t be part of reconciliation package.” CNN, September 8, 2021). It currently appears that Congressional Democrats may include an increase in the debt ceiling in a continuing resolution to keep the government open beyond September 30. This procedure would need at least 10 Republican votes in the Senate and, no doubt, Republicans will not want to be blamed for a government shutdown. However, they may be willing to do so, as a way of embarrassing the Administration and impeding the Democrats agenda.
There are, of course, multiple risks associated with this brinksmanship and investors will need to pay attention to this issue over the next few weeks.
However, even if the government remains open, the debt ceiling is lifted and the infrastructure and reconciliation bills are passed, the decisions made in getting to these deals will have important implications for investors.
One very direct issue is taxes.
On Sunday, House Democrats circulated a plan to fund, or mostly fund, their proposed $3.5 trillion in spending in the reconciliation bill. The suggested provisions include:
• Raising the top marginal income tax rate from 37% to 39.6%, with the top bracket starting at $400,000 for individuals and $450,000 for married couples, and adding a further 3% surtax on individuals with income over $5,000,000.