Washington Could End Up Cutting Defense Spending
Despite rising geopolitical tensions and clear majority support, it's entirely possible that the current fight over the debt ceiling could result in reduced defense spending.
There are several reasons to be concerned about the ongoing debt ceiling fight in Washington. Both sides appear deeply entrenched in their positions, making it challenging to find common ground. Additionally, the voting dynamics in the House pose challenges for the current Speaker. Moreover, it remains uncertain whether the White House and the judiciary would accept alternative methods to avoid default in case Congress and the White House fail to reach a deal.
The consequences of a default are challenging to predict, but it would likely cause significant disruption to the stock market and financial firms. This is because default would raise questions about the value of treasury bonds, which are considered a fundamental safe asset that institutions rely on during times of distress. Such disruption could lead to volatility in the markets, reduced investor confidence, and potentially severe economic consequences. I’ll leave it to those with economics expertise to provide a more comprehensive understanding of the potential implications.
Instead, I want to focus on the potential impact of the debt ceiling fight on U.S. defense spending, something that I have a bit more experience tracking and working with (though my track record on forecasting it is as mixed as anyone’s). For those of you not following the state of play, I’ll provide a quick recap:
The Treasury Department currently estimates that it will run out of borrowing ability some time in early June (the exact “X” date is not yet firm)
House Republicans have passed legislation that would raise the debt ceiling for roughly one year in exchange for $4.5 trillion in unspecific cuts. The cuts would come from a wide range of sources, including, but not limited to non-defense discretionary spending, ending the White House’s planned student loan forgiveness program, repealing the IRA adopted in the last Congress, and various reforms to make it harder for people to get Medicaid and SNAP
Senate Democrats and the White House have said that they will not negotiate over the debt ceiling but are open to deficit reduction as a separate conversation
On Tuesday of this week, the four leaders of Congress (House Speaker Kevin McCarthy (R-CA), House Minority Leader Hakeem Jeffries (D-NY), Senate Majority Leader Chuck Schumer (D-NY), and Senate Minority Leader Mitch McConnell (R-KY)) met with President Biden at the White House
While both sides maintained their positions, it does seem like conversations are ongoing about a budget deal that could be paired with a debt ceiling increase, though the details of any of that remain murky
All of these factors suggest that the FY 2024 defense topline may face significant pressure in the coming weeks. The debt ceiling negotiations and the need for Democrats to secure a win could potentially result in a reevaluation of defense spending. Previous deficit negotiations have seen Democrats push for cuts to defense spending as an alternative to cutting non-defense discretionary spending. Given the dynamics at play and the influence of various stakeholders, it is plausible that defense spending could become a target in the negotiations. However, it's important to note that the outcome is uncertain, and the extent of any potential cuts remains unclear.
Now, you may ask, why would defense spending come under pressure - it’s specifically excluded from the House GOP bill and the topline that was adopted for FY 2023 had broad support (the FY 2023 NDAA, the best stand-alone proxy for the FY 2023 spending levels, passed 83-11 in the Senate and 384-37 in the House). Well, the issue is that in negotiating the deficit reduction package that will pair with the debt ceiling, the Democratic Party is going to need a win. In order to maintain the pretense that the budget negotiations were done separate from the debt ceiling, there will need to be negotiations and both sides will need to claim some wins. I don’t believe it’s enough for the Democrats to say “we reduced cuts to non-defense from 22% to 8%”, they’re going to need to have forced something on Congressional Republicans. It is in this space that the threat to defense spending levels will arise.
In previous deficit negotiations, Democrats have generally pushed for two things as an alternative to cutting non-defense discretionary spending - increased revenue and cuts to defense spending (see the proposals made by Obama in this article from the 2011 debt ceiling stand-off). So it stands to reason that these will be where they look to extract a win this time as well. And of these two, I think it is more likely that Republicans will give way on defense spending than on tax increases. Budget hawks seem far more willing to threaten GOP leadership than defense hawks, giving them more sway in these negotiations. Thus my belief that defense spending may face cuts in the debt ceiling deal.
This is not to say that such an outcome is guaranteed - I think the odds on a failure to reach a deal are pretty high. It’s also possible that Democrats will accept just reducing the cuts to non-defense spending given that a decent portion of both the House and Senate Democratic caucus is concerned about geopolitical security. However, the odds on a deal have to be viewed as being fairly high and, in the event of a deal, I believe Democrats will push for a win and that win is likely to be defense spending. What the depth of these cuts will look like is unclear - hopefully we don’t see another version of sequestration being imposed, but it is certainly possible that you could see hundreds of billions of dollars cut out of defense budgets in the next decade. As negotiations continue, defense budget watchers should be paying close attention because this could be a major anchor on planned defense activity for years to come.