Divided Government – Policy implications

While yesterday’s election was not the large red Republican wave that polls had anticipated it appears that Republicans will narrowly take control of the House, and that control of the Senate is likely to be decided in a GA runoff.

Democratic candidates did better than expected in both the House and Senate.  In the House at this point only two incumbent Democrats appear headed for defeat but Republicans won control by winning open seats that were largely created by redistricting.  At this point it appears that the Republican House majority will be 5 to 10 seats similar to the 5 seat majority Democrats have today. Just as Speaker Pelosi had to make tough decisions to keep her moderate and progressive members together McCarthy and the Republicans will have a similar challenge.

Just as in 2020 it appears that control of the Senate will be determined in a runoff race in Georgia where state law requires a winning candidate to get 50% of the vote.  At this point while Senator Warnock is ahead of Walker he is falling short of 50%.  A runoff will be held on December 6 with control of the Senate on the ballot.

Bottomline is that with the House going Republican, and the Senate undecided, the US will have divided government for the next two years.

The most important factor to keep in mind as the US enters into an era of divided government is that the checks and balances of the Presidential veto will come into play starting on January 3^rd when the new Republican Congress takes control. The Republican majority is far from the supermajority that would be required to override a Presidential veto.  Furthermore, since the decline of moderate Democrats in the House there is almost no issue where a coalition of Republicans and Democrats would unite to get the two-thirds required to override a veto.

There are three tools that the Republican majority will be able to use to influence policy: first is the power of the purse to deny funds for areas traditionally supported by Democrats but opposed by Republicans.  Second is Congressional hearings. Finally if Walker wins in December Republicans can score political points by passing a so-called message bill that won’t become law but makes a point to set the groundwork for 2024.

Spending

When the Congress meets next month they will need to extend the government funding bill which funds the US Government until December 16.  This will be the last opportunity for a government funding bill to pass with Democratic majorities. The budget bill still faces the hurdle of 60 votes in the Senate and Senate Republicans are likely to be emboldened knowing that the new year will see a Republican House.

A big decision for the Republican leadership will be whether the new spending bill should run for the entire fiscal year until October 1, 2023 and let Rs write the budget for the new year or have another short-term CR that runs until February or March when Republicans will control the House.

Markets have of course read this book before and failure to pass a new budget by the 12/16 deadline runs the risk of a government shutdown. 

Debt Ceiling

Related to the spending bill is the national debt ceiling.  The US is the only major economic power that operates with a debt ceiling.  The ceiling dates back to WW I when the government had to raise money to support the war effort.  Since that time the ceiling has been raised over 90 times and it is obviously a must pass bill, but it comes with lots of political risk.  The current debt ceiling is $31.4T and is expected to allow the government to issue new debt until some point in 2023, perhaps as late as the second half of the year. However, at some point the ceiling will need to be raised and with divided government the fight will be messy and create headline risk for markets.

The Treasury Department is the agency that issues government debt and hence monitors the debt ceiling.  At some point in 2023 the Treasury Secretary will notify Congress that the ceiling is close to being reached and will give a date when Congress must act.  Failure to act is of course not a real option as the debt ceiling merely allows the government to pay bills that have already been incurred.  But in the past the US Treasury has threatened to delay an auction or miss an interest payment due to lack of funding capacity. 

Raising the debt ceiling has been a difficult vote dating back to the days I worked on Capitol Hill. It is especially tough for Republicans who know that if they vote to increase the ceiling they run the chance of a primary opponent running to their right and saying the vote to increase the debt ceiling marks them as a big spender.  It is a charge easy to demagogue and almost impossible to explain.  The Republican Member I worked for was a moderate who won with 60% of the vote in the General Election but always voted against the debt ceiling raise to protect his right flank. 

Similarly Democrats in competitive districts know that a vote to increase the debt ceiling will be used against them by Republicans in the general election. But even Democrats who don’t worry about the vote are reluctant to bail out their Republican colleagues from making a tough vote.  The real challenge for the new Republican Speaker is that it is the responsibility of the majority party to get this tough bill through.  Even if every Democrat would vote for the bill it would still fail without Republican support. 

Beware of a lot of ugly headline risk, hot rhetoric and bargaining over the debt ceiling in the coming months.

Hearings

The authority of a Committee Chair is one of the most powerful in DC.  A Committee Chair decides what hearings are going to be held, who the witnesses are, and if and when a piece of legislation is considered by the Committee.  It is almost impossible to move a bill through Congress, especially the House, without the support of the appropriate Committee Chair.

Republicans in Congress have made clear they want to hold extensive hearings into some of the hot button issues where Republicans believe they can embarrass Democrats.  These topics can range from the purely political like Hunter Biden and Impeaching President Biden to big policy issues such as China/Taiwan policy to the origins of the Covid epidemic and lockdowns. 

With the role the FBI has played into the investigation of President Trump and the documents he had at Mar-a-Lago, Rep. Jim Jordan, who will chair the House Judiciary Committee, has indicated he will want to look into both the FBI and the leadership of the Justice Department.  Investigating the Mar-a-Lago raid may give the new Republican House leadership an issue where they can incur favor with former President Trump who continues to play an outsized role in the Republican Party.

Immigration

One issue where I believe we may see some bipartisan cooperation is immigration.  Polling seems to indicate that Republicans improved their performance on Election Day with Hispanic voters; this may serve as a springboard for bipartisan legislation that would deal with long overdue reform of the US immigration system.  Many believe that some of the sectors of the economy that are short on workers would encourage action on the issue; and as both parties vie for the support of Hispanic voters this could be an issue where the two parties can find common ground.

International Relations

With the war in Ukraine, the need to deal with Russia and President Putin and the growing tensions with China and US ally Taiwan there is no shortage of issues for Republicans to press the Biden Administration in the area of international relations.  Republican leaders have also expressed interest in holding hearings on the US withdrawal from Afghanistan which appeared chaotic and lacked planning. 

Ukraine will be a topic of focus as the extremes of both parties are getting Ukraine fatigue and both progressive Democrats and far right Republicans have a history of taking positions that are more isolationist than their party’s mainstream. 

A few months ago after Speaker Pelosi’s trip to Taiwan there were talks of legislation to reaffirm the US commitment to Taiwan; but our China/Taiwan policy is predicated upon agreements that date back to President Nixon and Henry Kissinger and the general principle of One China.   The Biden Administration effectively worked with its Democratic allies in Congress to put the brakes on a confrontation with China; Republican leaders may not be as accommodating.

Tax Policy

Taxes is one of the great divides between the two major political parties in the US, and with their hands on the levers of power they will undoubtedly try to reverse some of the tax policies passed by the Democrats in the Inflation Reduction Act and enact new ones that create incentives for investors and energy.  Republicans will have leverage when the budget and debt ceiling are considered, but it is unlikely that Congressional Democrats or President Biden will give much away on tax policy.