Short-Term Benefits, Long-Term Blind Spots in Budget Deal

Jason Stipp: A budget deal was proposed in Washington on Wednesday, and nobody in D.C. seems particularly happy about it. But what does it mean for investors?

I'm Jason Stipp for Morningstar. Joining me is director of economic analysis Bob Johnson to give his take on the proposed budget deal for the economy and for investors.

Thanks for joining me, Bob.

Bob Johnson: Great to be here today.

Stipp: Let's talk about the outlines of the budget deal. What's in it? So far, it's a proposal; it's not law yet. What are they are proposing to handle some of these budget issues that we've been facing?

Johnson: In the short run, they're going to allow a slightly greater increase in spending, about $65 billion worth, and then they'll also have over a longer period of time about $82 billion worth of things that reduce the deficit. So net, we've got a little bit of deficit reduction here from this package, with a little bit of a short-term break from the sequester.

Stipp: That's the first key thing. The sequester has been lifted essentially in 2014 and 2015, but then extended on the tail-end. So in 2016, the sequester cuts, if nothing else happens between now and then, would come back into full force.

Johnson: Absolutely. We've pushed it down the road a little bit again. If they found the cuts so onerous, and the Republicans couldn't stand the defense cuts that were in that bill, well, they're going to come back to life again in 2016.

Stipp: Another part of this proposed budget deal handles unemployment benefits. The extended unemployment benefits will go away at the end of this year, if nothing separate happens.

Johnson: The extended unemployment benefits do run out on Dec. 28. There were some thought that they were going to tack on [an extension] to the bill, and they did not. So, it looks like, right now, unless there is separate legislation, which may happen, that those extended, longer-term unemployment benefits will run out on Dec. 28.

And that affects a rather large part of population, at 1.3 million people. I'm thinking maybe somewhere along the line there is some small extension or something that weans people off of it, and doesn't cut it cold turkey on the 28th of December.

Stipp: Something else the deal handles is pensions, with some pension reform for federal workers and the military.

Johnson: You put all the different pension things together, and it reduces costs by about $18 billion. It's not an insignificant part of the whole deal.

Corporations will pay more to guarantee their pensions; military people that retire early won't get the same cost-of-living increases that somebody over 62 will get; and federal employees will have to kick more in. So, three real factors that [account for] $18 billion in total.

Stipp: Medicare payments to doctors will be permanently lower now, according to this proposed budget.

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Johnson: Right. The payments were supposed to be about 2% lower, and that's been part of a number of spending bills, but it was kind of year-to-year extended, and now they've made it so those reduction in payments will extend out the full 10 years of the budget deficit reduction program.

Stipp: Another thing in this proposed budget is going to hit frequent flyers. What's that?

Johnson: The TSA fees. There will be an extra fee you'll see on your airline ticket for airline security. Those fees are going up, and maybe a fair amount. It's going to account for about $12 billion, almost $13 billion, of the deficit reduction that we're seeing.

It's not really a tax, because it doesn't cover the whole cost of security screening in the first place, but it's certainly an expense that all of us will see.

Stipp: One good piece of news for taxpayers is that payroll taxes will not increase as part of this proposed budget deal.

Johnson: That's right. There is no income tax increase, there is no payroll tax increase, there is no bracket change, there are no changes to speak of in what deductions are allowed, and so forth. There are a few corporate things that changed just a little bit--but really not much on that front. It's more of the status quo there.

Stipp: Wrap this up for us with respect to the deficit. We've seen some improvement in deficit since the financial crisis. Now, they're going to have a little more spending over the next couple of years. What does this mean for the deficit in the shorter term and what does it mean for the deficit in the longer term?

Johnson: With the deficit running about $600 billion to $700 billion, whether it shifts $45 billion or not in a given year isn't a big deal. So the numbers pretty much stand. We'll probably get somewhere around 4% for a deficit again this year, and maybe it trails down a little bit next year toward 3%, and then kind of bottoms out at that level before we start to go back up again in '21, '22.

Stipp: There are some big changes happening around 2023, which could cause the deficit to go up quite a bit, if they don't deal with it.

Johnson: That's right. The Social Security program, Medicare/Medicaid, and also interest on government debt--those three issues start to be a bigger and bigger problem as we go through time and really start to kick-in in 2023, but then we really have a longer-term impact.

The government looks out 25 years, at what happens in 2038, and that's when you really see some of the big numbers out there. Medical spending goes from 4% of GDP to 8% of GDP--that is, the government portion of that spending. That's a big number. Government spending is about 20% of the economy, and to have it go up 4% just for medicine is a lot.

Then you've got interest also going from 1%-2% of GDP to something that looks more like 5%. And then you've got Social Security going from mid-4% to about 6% over that time frame. So, all of a sudden government spending has gone from 20% of GDP to 26% of GDP, which is something we probably can't handle.

Stipp: But nobody is talking about these longer-term issues yet, not in this deal?

Johnson: Nobody is. All they dealt with this time was the short-term issue. They dealt with the discretionary spending, which is only, in ery round numbers, about $1 trillion of $3 trillion of government spending. They left alone Social Security, they left alone Medicare for the most part. So, there is really no big changes to the things that really need to be changed.

Stipp: Those are going to be bigger fish we'll have to fry later.

As an economist, how do you feel about the fact that they are going to let a little more spending happen for the shorter-term health of the economy--because the sequester, while good for the long-term deficit and getting our spending under control,did hurt the economy when it kicked-in this year?

Johnson: It was a huge hit in 2013. The deficit went down $400 billion in one year, and that's probably the most it ever has, in a dollar terms anyway. So, that was a big part of why we didn't grow faster in 2013. We probably could have grown a full percentage point faster if government cuts hadn't been so austere. And it looked like they were going to be bad in 2014 as well. And now we've backed off a little bit.

I think there are a few things that are good here about the bill. It did solve some of the short-term problems. Now, some of the uncertainty around, are we going to have a budget? Are we not? Are we going to get gored by the tax axe? Some of that uncertainty has been pushed aside for now, and that's probably the biggest benefit of the whole thing.

And the fact that the general framework of the budget-deficit reductions are still there, I think, is wonderful. I wish we would have taken a crack at entitlements, but nobody was really expecting it this time around. They're going to let the elections settle that one.

Stipp: I know that you'll be here to help us work through a lot of these issues as they are finally dealing with them in Washington. Thanks for giving us the update on this proposed budget today.

Johnson: Thank you.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.