How the debt could hamstring Trump's agenda

Schweikert warned that investors on Wall Street were starting to think twice about lending to the United States, a potential loss of confidence in Washington's tax and spending plans that could ripple across the economy.

Washington: When House Republicans gathered behind closed doors on Capitol Hill last week to hash out their plans for cutting taxes, Rep. David Schweikert sounded a note of caution.

The United States' fiscal problems were at risk of spiraling out of control, Schweikert, R-Ariz., told his colleagues. He warned that investors on Wall Street were starting to think twice about lending to the United States, a potential loss of confidence in Washington's tax and spending plans that could ripple across the economy.

"This ain't a game," Schweikert, a member of the House Ways and Means Committee, said in an interview. "This needs to temper both how we approach policy and how we communicate that policy."

Schweikert's view, echoed by other lawmakers at the meeting, was an early sign of the stark economic and political challenge that America's $36 trillion debt will pose for President Donald Trump.

Concerns about elevated interest rates and a growing deficit have bogged down Republican efforts to quickly pass Trump's agenda into law. The impending return of the debt limit risks a default that could upend global financial markets, and investors and rating agencies are on edge about the fiscal outlook.

"Categorically, absolutely the market is more focused and concerned about US fiscal and the implications for issuance and debt levels than was the case a decade ago," said Nathan Sheets, the chief economist at Citigroup and a former Treasury official.

Every president for a generation has faced a grim fiscal forecast when taking power. Health care and retirement costs have long been expected to skyrocket as the number of people retiring exceeds those joining the workforce.

But the situation has recently taken a turn that has alarmed economists and investors.

The annual gap between government spending and revenue surpassed $1.9 trillion last fiscal year, exceeding 6.6% of gross domestic product. That's a huge amount for a country that is neither at war or in the throes of an economic slowdown. It also far exceeds the historical average of 3.8 per cent of GDP over the past 50 years, according to the nonpartisan Congressional Budget Office.

Investors are the ultimate arbiters of Washington's fiscal health. For decades, even as deficits grew, interest rates were low and borrowers happily bought Treasury bonds to help the government pay its bills. But in the past few years, investors have become more sensitive about buying new bonds that can lose value as interest rates climb.

That has raised the possibility that Wall Street and global lenders will start to demand even higher interest rates on the bonds that the Treasury needs to issue to finance the deficit. Because US debt sets a benchmark for other loans across the economy, such a change could spill over into higher costs for Americans who borrow to buy cars or houses.

Trump's victory in November accelerated those concerns. Bond yields rose in the run-up to the Republican sweep as investors started to prepare to buy a new lump of debt to cover the roughly $5 trillion cost of extending the tax cuts Trump passed in 2017.

While analysts now believe that the cost of extending the 2017 tax cuts are baked into long-term interest rates, further deficit spending on additional tax cuts or spending programs could alarm the market and prompt a sell-off.

"I could see a moderate flare-up if we get a headline that has a giant deficit number attached to what this reconciliation bill is going to look like," said Blake Gwinn, the head of US rates strategy at RBC Capital Markets. "Maybe we get a mini panic."

To avoid that, Republicans are exploring dozens of ways to try to contain the cost of their legislation. But so far, the effort is slow going. Republicans are using a special legislative process called reconciliation to craft the bill, a procedure that allows the GOP to bypass Democrats in the Senate. A first step in that process is setting an overall price tag for the legislation.

Republicans on the House Budget Committee have compiled a 50-page document for cutting spending and raising revenue, laying out dozens of options such as imposing work requirements on Medicaid and repealing the tax deduction for interest on mortgages, according to a copy of the document viewed by the Times.

Many options on the list, though, would face opposition from other Republicans, and the party would need to band together almost unanimously to pass any legislation given its slim majority in the House. The House Budget document includes estimates for raising tariffs, for example, putting the revenue generated from a 10% across-the-board tariff at $1.9 trillion over a decade.

By including tariffs in the legislation, Republicans could formally count revenue they generate against the cost of extending the 2017 tax cuts. But many Republicans are hesitant to rely on tariffs as a way to pay the government's bills, even if Trump intends to use them to do so.

"I think tariffs can be short term," said Rep. Greg Murphy, R-N.C., a member of the Ways and Means Committee. "If China, for example, is undercutting us, if they correct their ways, then the tariffs go away. I think we have to have a dependable tax structure that helps us fund our government over the short term and the long term."

Even without putting tariffs into law, Republicans are planning to point to revenue that Trump's executive actions generate as offsetting the cost of their tax cuts regardless of whether CBO and the Joint Committee on Taxation include them in estimates of the bill's cost.

"Those revenues, according to how the wondrous CBO and Joint Tax scores, they won't give us credit for the hundreds of billions or maybe trillions of dollars that will be coming in, depending on what those tariffs look like," said Rep. Jason Smith, R-Mo., the chair of the House Ways and Means Committee. "But what we have to do as lawmakers is look at the complete fiscal health of the nation."

Some House Republicans have also started to consider the possibility of extending the 2017 tax cuts for only a few years to hold down the cost of the legislation, according to lawmakers involved in the deliberations. Republicans made many of the tax cuts temporary in the first place to keep the headline cost of the original bill lower.

The hunt for other revenue and spending cuts is driven in part by the fact that Republicans hope to do more than just temporarily extend the 2017 tax cuts. They are also planning to cut taxes further, including by exempting tips from income taxes. The document detailing options for the legislation also mentions cutting corporate taxes as low as 15% from 21% now.

A relatively small group of House Republicans from New York, New Jersey and California are also demanding an increase in the state and local tax deduction, often called SALT, in return for their vote. Raising the $10,000 limit can be expensive, though, and lawmakers from the high-tax states view doing so as existentially important for their political prospects.

"I don't accept the premise that anything we do has to be viewed as a cost," said Rep. Nick LaLota, R-N.Y. "But to the extent that it is, that's not the most important variable to the SALTiest Republicans."