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Conclusion:  The Gang of Six proposal will likely pave the way to a debt ceiling extension, but a credible and detailed deficit reduction plan is still a mirage.

The stock market’s reaction to the Gang of Six deficit plan was without a doubt positive.  The SP500 ended yesterday up 1.6% and the NASDAQ composite ended up 2.2%.  This reaction was interesting given the credit markets have been signaling that any risk of a U.S. government debt default was minimal based on the fact that credit default swaps for U.S. government debt have not budged this year. The equity markets did, however, rightfully cheer on compromise in Washington, DC, even if default was never realistically on the table.

There is no doubt compromise in Washington, DC, especially in these partisan times, is indeed a good thing for America.  While Republican leadership in the House continues to make noise about not being satisfied with the Gang of Six plan, the polls and American voters are shifting away from them.  In the last few days two meaningful polls have been released that likely influenced some in the Republican leadership in the Senate to step away from stalemate on the debt ceiling debate. The key polls were as follows:

  1. CBS Poll on July 18th: This poll from CBS showed that 46% of those polled believed the debt ceiling should be increased and 49% were against it.  Almost a month earlier, CBS ran the same poll and only 24% of those polled believed the debt ceiling should be raised and 69% were against it.  Clearly, on some level, the dramatic shift amongst Americans as it relates to the debt ceiling is influencing a Republican willingness to compromise.
  2.  Gallup Poll on July 18th: The key question asked in this poll was: “What would you like the people in government who represent your views on the debt and budget deficit to do in this situation?” Interestingly, in line with the shift noted in the CBS poll mentioned above, 66% of those polled indicated they would like their political representative to agree to a compromise plan, even if it is a plan they disagree with.

Given the shift in national sentiment it is likely not surprising that the Senate has come to a compromise and that is, as the equity market indicated, positive on the margin, at least in the intermediate term.  Conversely, last night the more conservative House, influenced by the Tea Party, passed a $6 trillion deficit reduction bill with a constitutional balanced budget amendment.   This piece of legislation has been dubbed “Cut, Cap and Balance”.  In contrast to the Gang of Six plan, which has been lauded by President Obama, the House bill is very unlikely to find support in the White House.

In reality, passing “Cut, Cap and Balance” was likely more of a symbolic move.  House Majority Leader Eric Cantor signaled as much when he stated the following about the Gang of Six proposal:

“This bipartisan plan does seem to include some constructive ideas to deal with our debt.”

This seems to imply that Cantor is ready to dance, which isn’t surprising given the polls are shifting away from him.

Our core issue with the Gang of Six proposal is its gross lack of detail, which potentially makes the ability to successfully implement the plan challenging.  The key points in the five page memo are as follows: 

  • Cutting $500 billion in discretionary spending over 10 years, including defense;
  • New discretionary spending caps through 2015;
  • Requirement of congressional committees to produce legislation within six months that finds billions in savings in entitlement programs over 10 years;
  • Creation of a 67-vote threshold to make it difficult for the Senate to exceed its spending caps;
  • Overhaul of the tax code, eliminating many tax breaks and using the savings to reduce marginal income tax rates;
  • Elimination of the $1.7 trillion Alternative Minimum Tax and the $298 billion Sustainable Growth Rate formula for Medicare (known as the “doc fix”); and
  • An overhaul of Social Security.

Interestingly, this may be a way of kicking the can down the road on a grand scale as the Gang of Six plan will be utilized to extend the debt ceiling, but the real work on implementation and legalizing will come at the committee level and over a longer period of time, perhaps years.

In the Congressional Budget Office’s current baseline case from January 2011, the combined federal budget deficit from 2011 to 2021 is $6.9 trillion.  Currently, Medicare, Medicaid and Social Security combine for 42.4% of annual federal budget outlays.  By 2021, as outlined in the table below, these three programs will combine for more than half of federal budgetary outlays.  In total, by shifting from 42% of federal spending in 2012 to 50%+ of federal spending by 2021, the combined programs of Medicare, Medicaid and Social Security are responsible for contributing an incremental $2.3 trillion to the deficit.

Gang of Six Plan . . . A Catalyst without Fundamentals - 1 

The math is pretty simple, if we want to solve the deficit problem, we need a credible plan to reduce future healthcare and social security spending.  Without further detail on how this is going to be effected, it is difficult to get very excited about the Gang of Six proposal from a longer term prospective.  In the shorter term, this plan will likely allow the debt ceiling to be extended.  As far as being a credible deficit reduction plan though, the devil is in the as of yet unseen details.

Daryl G. Jones

Director of Research