Congress Returns as Fiscal Cliff is Straight Ahead

Key Takeaways

• House starts to assemble massive $3.5T Budget Reconciliation Bill with opposition growing from moderate Democrats in both House and Senate. Tax increases for both corporate and personal taxes part of Reconciliation Bill. New Democratic proposal would increase corp. tax to 26.5% and capital gains to 25%.
• Speaker Pelosi needs to navigate path for Senate passed bipartisan infrastructure bill and Budget Reconciliation.
• Market risk issues on the table in DC center on government shutdown and debt ceiling. Potential shutdown at end of fiscal year on October 1.
• Democrats plan to avoid debt ceiling crisis by adding it to government funding bill. Republicans could vote against bill but not filibuster the government funding bill that has debt ceiling resolution. If Rs filibuster bill they may take blame for government default. Democrats say there are multiple ways to increase debt ceiling other than government funding bill; but these alternatives are well kept secret.

Bipartisan Infrastructure Bill

The Senate returns today and the House next week as both chambers face a daunting list of must-pass bills to keep the government open and running and deal with infrastructure and Budget Reconciliation.

While the House will not be in session this week the spotlight will be on the House Ways and Means Committee that starts to assemble the huge $3.5 Budget Reconciliation Bill.

The Committee has jurisdiction over two large areas: social policy issues including a vast expansion of Medicare/Medicaid and the Child Tax Credit. They also have responsibility for the contentious issues of corporate and personal taxes. The White House and progressive Democrats have put some very significant issues on the table. Perhaps the least controversial ideas are increasing the corporate tax rate and raising the top marginal rate for the wealthiest Americans. More controversial are proposals to increase the capital gains tax and the step-up provision in the federal estate tax. Democrats reportedly are looking for a top corporate rate of 26.5% up from the current 21% and to raise the capital gains rate from 20% to 25%, well below the 39.6% proposed by the White House.

The future of both the spending proposals and the tax proposals will likely be determined by a small group of moderate Democrats who will play a large role due to the paper-thin majorities Democrats have in both chambers – 3 votes in the House and tied Senate. Moderate Democrats are likely to push for changes in the tax provisions proposed by the White House and backed by progressive Democrats, and the rates released over the weekend appear to acknowledge the views of the moderates. The Congressional leadership has set a tentative date of September 27 to pass Budget Reconciliation, but Senator Manchin on Sunday said that he both opposes the $3.5T package and that September 27 is way too quick to consider such a wide-ranging bill.

Perhaps the biggest thing to watch as September 27 approaches is the commitment Speaker Pelosi made for a vote on the bipartisan infrastructure bill. Before the Labor Day break, she agreed to have a vote no later than September 27; but as progressive Democrats have vowed to oppose the infrastructure bill before they see action on the $3.5T Reconciliation Bill the Speaker will have tough choices to make. Hard to see Democrats blocking one of President Biden’s top achievements, especially as his poll numbers drop.

Not only does leader Schumer face issues on the $3.5T package from Senator Manchin and a few others; but in the House Speaker Pelosi, who only has a four-seat majority, can only lose 3 votes. The group of 10 moderates who fought for a vote on the Senate bipartisan infrastructure bill are likely to object to any Reconciliation Bill that approaches $3.5T and will be livid if the Speaker backs off the September 27 vote on infrastructure making the Reconciliation process a test of Pelosi’s leadership.

While Reconciliation and infrastructure may be tough, perhaps the issue with the biggest potential market impact is funding the government for FY 2022 and dealing with the debt ceiling. As we have seen before, Congressional failure to provide government funding prior to October 1 can lead to a government shutdown. Republicans have vowed to vote against the government funding bill.

Last week Treasury Secretary Yellen informed Congress that the debt ceiling is likely to be reached in October; hence Congress must take action in order to prevent a US Government default. Currently, Congressional Democrats are developing a strategy where they will put the debt ceiling and government funding into one bill and dare Republicans to oppose it. Senate rules have become somewhat misrepresented in recent years, giving the impression that any bill needs 60 votes to pass. In fact, bills pass the Senate with a simple majority, but 60 votes are needed if opponents seek to filibuster a bill. It would be possible for Republicans to get on record opposing government spending by voting against both the government spending and the debt ceiling suspension or increase, but not filibustering the bill to allow the legislation to pass with only Democratic votes. This decision will be up to Republican Leader McConnell. Republicans have hopes of recapturing the majority after next year’s election; but if there is a shutdown or worse a government default blamed on Senate Republicans, that could change the 2022 calculus.

While Democratic leaders say there are several ways they could increase the debt ceiling, tying it to the government funding bill is the only one that has been discussed. If there is a plan B it is a well-kept secret.

Bottom line: lots of risk for markets in coming weeks.