After final approval by the Senate, President Obama signed into law a historic legislative package combining new authority for the US Government to borrow at least $2.1 trillion with a variety of statutory provisions designed to offset such new borrowing by mandating spending reductions and other savings over a 10-year period.

Every sector of the US economy is bound to be affected by the debt ceiling deal, as it incorporates federal spending reductions of nearly $1 trillion as well as a procedure to identify this Fall as much as $1.5 trillion in additional deficit reduction including from entitlement programs and tax reform proposals. These additional measures would emerge from a bipartisan joint Congressional committee and would receive votes in Congress by December 23, 2011, assuming a majority of the committee votes in favor of them. In the event that the committee is not able to approve additional deficit reduction measures, an across-the-board budget “sequestration” will occur, leading to $1.2 trillion in spending reductions that will include both defense and non-defense spending and some Medicare programs.

Key Elements of the Debt Ceiling Deal

The debt ceiling deal will immediately allow the federal government to borrow $400 billion, to avoid default, and permit President Obama to raise the debt ceiling again this fall by $500 billion unless Congress passes legislation preventing it. This $900 billion in additional borrowing will allow the Treasury to pay its debts through early next year. In exchange, the deal cuts approximately $917 billion from federal spending over ten years, beginning in Fiscal Year 2012.

The immediate reductions in spending will affect discretionary spending at federal agencies, and does not impact mandatory spending such as Social Security, Medicaid, and Medicare. Specifically, the deal caps FY 2012 spending at $1.043 trillion, which is $7 billion less than the FY 2011 level. It is important to note, however, that this spending cap is nearly $24 billion higher than what the House of Representatives passed earlier this year in its FY 2012 budget resolution. Now that the debt deal legislation has been signed into law, Congress will have to pass a FY 2012 appropriations package that stays within the spending limit imposed by the debt ceiling deal. Additional annual discretionary spending caps will be imposed for each year covered by the agreement.

In addition to these spending cuts, the deal increases funding for Pell Grants for low-income students by $17 billion spread across FY 2012 and FY 2013, however it is offset by reductions in student loan subsidies and will not increase the deficit.  The deal does not affect the individual award level that an eligible student can receive under the Pell Grant program.

The second phase of the deal will allow the debt ceiling to be raised up to an additional $1.5 trillion if Congress approves deficit reduction of greater value recommended by a bipartisan 12 member joint Senate/House congressional committee, or if it passes a Balanced Budget Amendment (BBA) to the Constitution with the necessary two thirds majorities and sends it to the states for ratification. Since Congress is unlikely to adopt a BBA, the recommendations issued by the joint committee will be a particularly important part of this process. The committee is expected to examine all the available options to reduce the deficit, including additional budget cuts, changes to entitlement programs, and tax code reform, and produce its findings by November 23.

If Congress fails to pass either the joint committee’s recommendations or the BBA, the deal triggers up to $1.2 trillion in across the board spending cuts to both discretionary and mandatory programs, beginning in 2013. These automatic “sequestration” cuts would be split equally between defense and non-defense programs, and mandatory programs including Medicare (on the provider side, not the beneficiary side), and are designed to encourage Congress to act on the recommendations of the joint committee. Other programs, such as Social Security, Medicaid, Veterans benefits, and military pay would be exempt from the sequestration cuts. In the event that sequestration is triggered, the President could seek up to $1.2 trillion in additional borrowing authority.

The debt ceiling deal includes substantial compromises by both parties made in order to avoid a historic default by the federal government. Although it is not the “grand bargain” that President Obama and Speaker Boehner had hoped to make, it makes significant changes in federal spending that will affect nearly all Americans. First and most immediate is the $917 billion in spending cuts over the next ten years, starting with the 2012 budget. These cuts will impact nearly every federal agency and reduce the amount of funding available for federal grants, research and development, education programs, infrastructure projects, and other discretionary funding decisions.

Second, the deal ensures that additional deficit reduction measures will become law, either through the approval of the recommendations of the joint committee or through across the board cuts enacted if the recommendations are rejected. The latter approach was included as an incentive to adopt the joint committee recommendations, since sequestration cuts would impact programs favored by both parties. Although the proposals made by the joint committee will not be available for several months, the committee is likely to examine many of the ideas contained in a report issued in December, 2010 by the National Commission on Fiscal Responsibility and Reform chaired by former Senator Alan Simpson (R-WY) and Erskine Bowles, who served as Chief of Staff to President Clinton. The Bowles-Simpson plan included many specific proposals, such as imposing discretionary spending caps, reducing corporate and individual tax rates in exchange for eliminating a variety of tax credits and deductions, and changes to entitlement programs including Medicare, Medicaid, and Social Security that would produce savings.

Analysis

Former Senator Byron Dorgan (D-ND), Co-Chair of Arent Fox’s Government Relations practice, said: "It was critically important to get this agreement to avoid a default. But still so much more needs to be done. After this agreement there will be about $7 trillion added to the debt in the next ten years rather than the expected $10 trillion. That's progress in the right direction, but it still does not reconcile our spending with our revenues. This agreement will create a stampede in the coming months with 12 members of Congress in a type of Super Committee to decide which spending programs they believe should be cut and how large the cuts should be. There is going to be an unprecedented lobbying frenzy by every interest group and federal agency in America trying to protect their specific program."

Former Congressman Phil English (R-PA), Co-Chair of the Arent Fox Government Relations practice, said: “After you wade through the competing Greek Choruses of spin surrounding the bipartisan agreement, a few basic facts shine through that suggest this deficit reduction architecture could be more enduring than past attempts. First, the agreement has strong enforcement mechanisms that give a broad cross-section of Congress a deep stake in finding and approving appropriate cost savings for long term deficit reduction. The threat of sequestration at the end of this year will bring legislators to the table to consider dramatic entitlement reforms and potentially new revenues. Second, the prospects for near term reform of the tax code are dramatically increased, although the process for shaping that reform is less clear in the wake of the creation of a new joint committee to assume jurisdiction over the deficit reduction process. Finally, the two step process contained in the agreement will make the framework easier to sell, but will create enormous uncertainty in defense and health care budgets. The best news is that the agreement has the credibility to reassure international financial markets about the fiscal discipline of the United States and the credit worthiness of our debt issues, at least for the time being.”

The debt ceiling deal will result in substantial cuts to federal spending and likely result in changes to entitlement programs and the tax code, which will impact individuals and businesses alike. The Arent Fox Government Relations Department will continue to monitor the latest federal fiscal developments to determine the impact upon our clients. Major changes are ahead and we look forward to working with you over the next five months as this two-phase budgetary process unfolds.

To view the text of the debt ceiling legislation, click here.

To view a section by section summary, please click here