By Joseph J. Schatz, CQ Staff
The prospect of painful automatic spending cuts in January 2013 has been one of the main factors keeping difficult budget talks alive over the past month. It may also serve to contain the fallout among investors if negotiators fail to bridge a persistent divide in the coming week.
The sequester, as those automatic cuts are called, remains a potent political topic as the Joint Select Committee on Deficit Reduction struggles to reach a deal. Lawmakers on the panel continued to circle each other Monday, each side waiting for the other to budge and talking among themselves as the clock ticked ever more loudly toward their November 23 deadline. Major issues, including revenue increases, entitlement spending cuts and the use of budgetary war savings, remained in dispute.
Both sides have taken steps in recent weeks to avoid blame if a deal falls through, and recriminations are all but certain if the supercommittee does not meet its statutory mandate of $1.2 trillion in budgetary savings.
Some lawmakers have pointed to Standard and Poor’s decision to downgrade U.S. Treasury securities after the bitter debt-ceiling debate this summer. They have warned that if the supercommittee does not produce a deal, investors around the world will punish the United States for its political gridlock.
Still, bond traders and investors, not ratings companies like Standard and Poor’s, determine interest rates through their market transactions. And the consequences of a supercommittee breakdown — $1.2 trillion in spending cuts spread over nine years and applied equally to defense and non-defense programs, with some exceptions — are written firmly into law.
In a memo last week, the research arm of Goldman Sachs said that although a supercommittee failure “would be far from ideal and could weigh on sentiment, the practical near-term repercussions seem limited” because of the statutory sequester.
“At this point there is little reason to believe that either S&P or Moody’s would downgrade solely based on a failure to agree,” Goldman Sachs said.
House Majority Leader Eric Cantor (R-VA) refused to tell reporters Monday whether he supported leaving the sequester in place. “I don’t think the sequester will be applicable because I believe that they will reach an agreement by the deadline,” Cantor said.
Limiting the Automatic Cuts
Cantor’s optimism notwithstanding, defense hawks remain concerned and are pressing for legislation to blunt the impact of automatic cuts on the Pentagon.
Senator John McCain (R-AZ) released a letter from Defense Secretary Leon Panetta on Monday that detailed the drastic security cuts a sequester would impose on the military. Also, a pessimistic analysis on Monday from economists with RBC Capital Markets illustrated financial market concerns about a possible repeal of the cuts.
“The best possible outcome is the triggers kick in; the worst possible outcome is you get nothing. The odds of the latter seem to be growing,” the RBC analysis said.
Pressuring Democrats into reordering a sequester might be successful in an election year, but with investor sentiment in mind, House Speaker John Boehner (R-OH) has made clear that he does not see blocking the automatic cuts as an option.
President Obama also vowed last week that he “will not accept” any effort to turn off the sequester.
Their positions were designed to maintain pressure on the supercommittee, but they might have the effect of reassuring the investors that, one way or another, the accumulated deficit will be reduced by more than $1 trillion over the next decade.
While the co-chairman of the joint committee, Rep. Jeb Hensarling (R-TX), said Sunday that he would be open to redesigning the sequester in a “smarter fashion,” he maintained the importance of the $1.2 trillion guarantee.
Seeking Paths to a Deal
Meanwhile, although the supercommittee has not had an official meeting for two weeks, talks among panel members, sometimes only in pairs, continued on Monday.
One such meeting in the office of Rep. Dave Camp (R-MI) described as “impromptu,” involved fellow panel member Rep. Chris Van Hollen (D-MD). After the 40-minute session, Van Hollen did not characterize the discussions. “We’re just talking about different ideas,” he said.
Hensarling said such talks have become more intense with the deadline approaching. “It’s intensified, everybody’s focus,” he said as he left the Capitol Monday evening. “There’s a lot of proposals and counterproposals out there.”
On Sunday, Hensarling also seemed to open the door to a potential two-step overhaul of the income tax code, a process that would include immediate tax changes followed by broader action by the tax-writing committees in both chambers. Boehner has long been open to such an approach.
But in their pitch to supercommittee Democrats last week, Republicans led by Senator Patrick Toomey of Pennsylvania were focused on an immediate rewrite of tax laws that would raise more than $300 billion in revenue while also reducing tax rates.
Supercommittee Democrats are considering making an offer that would include a two-step tax increase of between $600 billion and $800 billion, according to a Democratic aide close to the committee.
The proposal would encompass an immediate “down payment” of increased revenue and instructions for the House and Senate tax committees to overhaul the code by a later date.
Some conservatives oppose a two-step tax overhaul as too unpredictable and open-ended, and GOP aides have downplayed the idea that it would constitute a breakthrough.
One Republican source called a two-step process “difficult to execute,” arguing that it would require agreement up front on some of the most important issues, such as a revenue target and top tax rates. That would possibly make a two-step process no easier than a one-step overhaul.
Of course, lawmakers have had months to debate those tough questions, and the Republican offer last week to increase tax revenue appeared to have bridged little of the gap between the two sides.
To some factions in each party, the prospect of a sequester is more appealing than a compromise. Some conservatives, such as the Cato Institute’s Daniel Mitchell, have suggested that risking a sequester would be better than a deficit-reduction agreement that increases taxes.
From the other side, President Obama, who has focused far more attention recently on promoting his jobs and economic growth proposals, insists that any legislation must include a balance of spending cuts and tax increases. He continues to wield the sequester as a stick.
“The whole idea of the sequester was to make sure that both sides felt obligated to move off rigid positions and do what was required to help the country,” Obama said as he hosted foreign leaders in Hawaii on Sunday. “This doesn’t require radical changes to America or its way of life.”
Paul M. Krawzak and Sam Goldfarb contributed to this story.