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The president’s negotiating strategy is to be transparent about his willingness to make concessions in order to secure a “balanced” agreement. However, US$580 billion in new revenue from closing loopholes and reducing benefits for the wealthy was also included in the budget, something that is sure to ruffle some GOP feathers. Fiscal stimulus measures proposed for 2014-15 will also add to the deficit in the near term. The deficit projection under the President’s budget lands between the Democratic and Republican estimates (albeit much closer to the Democratic position). Essentially, the President has put the GOP leadership in a position where they must argue against increasing revenue through higher taxes for the wealthy. We witnessed how difficult that position can be during the fiscal cliff negotiations when the Republicans got nothing in return for higher tax rates on the rich. In short, revenue is the critical hurdle to an agreement that gets political leaders to the targeted US$4 trillion in deficit reduction over 10 years.
There is a chance that the GOP will not be able to make the concessions on revenues necessary to secure a broad deal, and thus decides to simply fund the government with another continuing resolution (CR) at current spending levels imposed by the sequestration. The CR would be passed either before the next shutdown deadline (September 27) or shortly thereafter. This result would be market-neutral, since it is the outcome that is already discounted, although it would mean that the onerous fiscal drag currently in place for FY2013 would go unaltered.
That said, a broader budget deal is not out of the question. Indeed, a deal is more likely than is currently anticipated by investors, which means it would be positive for risk assets.
This post was originally published by the BCA Research blog.