By Kate Davidson 

The spending deal congressional leaders announced this week would remove a key source of uncertainty heading into a presidential election year, but it won't translate into a big rise in government spending, muting its impact on economic growth.

The two-year pact will prevent steep automatic spending cuts from kicking in next year, which would have weighed on the economy. But spending would rise only about 3.5%, or $44 billion, over 2019 levels, and only 0.8% the following year, well below the current inflation rate. Overall, the pact would increase spending roughly $320 billion above budgets caps enacted in 2011.

As a share of the economy, next year's increase is in line with the rise in budget authority that Congress approved in the last two-year deal, keeping the government on the same spending trend, said Donald Schneider, an economist at Cornerstone Macro.

"That means we're keeping the fiscal impulse roughly steady," he said.

The deal is also in line with what most private forecasters and markets expected. Without a budget deal, the automatic spending caps known as the sequester would have reduced discretionary spending by 10% next year.

Though it only makes up about one-third of the federal budget, discretionary spending -- the part of the budget Congress can adjust -- includes many of the programs voters care about, such as funding for the military, education, food safety, national parks and cancer research. Though consumer spending is the biggest driver of economic growth, federal spending is also a major component.

Ernie Tedeschi, an economist for Evercore ISI, estimates gross domestic product will grow 2.4% in fiscal 2020 under the deal, higher than the 2% growth expected if the sequester cuts had taken effect, but is in line with what forecasters had already expected.

The agreement, aside from lifting the spending caps, also removes the threat of an impasse over raising the federal borrowing limit. Without an increase, the U.S. could run out of cash to pay its creditors by early September.

Senate Majority Leader Mitch McConnell (R., Ky.) defended the spending increases in the deal, over which some fiscal conservatives objected.

"I think it's the best we could have done in divided government. The alternatives were much worse: a one year [continuing resolution], a sequester, perpetual chaos," he said.

Federal Reserve officials, who are widely expected to cut interest rates at their meeting next week, had flagged fiscal policy as a source of economic uncertainty. The deal removes the potential for debt limit drama this fall, suspending the borrowing limit until July 31, 2021, though it likely won't alter Fed officials' near-term policy plans.

The pact, which still must be approved by Congress and signed by the president, also offered the latest evidence that lawmakers in both parties are willing to tolerate much higher deficits to advance their policy priorities, a stark reversal from the budget austerity kick that consumed Washington under the Obama administration.

The shift is happening as federal deficits and debt levels are on track to soar in part due to the 2017 tax cuts and the higher spending under the current budget deal. That comes despite sturdy economic growth and a robust labor market, which typically lead to smaller deficits. The White House Office of Management and Budget estimated this month that the federal deficit will top $1 trillion in fiscal 2019.

The deal would offset roughly $77 billion of the $320 billion in new spending above the 2011 caps, about half of what fiscal hawks in Congress and in the administration had sought. The Congressional Budget Office estimated Tuesday the deal would add roughly $265 billion to deficits over the next decade, though the figure would be much higher if spending levels continue on the same trajectory.

The deal would also end the Budget Control Act, the series of spending cuts that Republicans negotiated with President Obama in 2011 in an attempt to curb rising federal deficits. Congress has effectively avoided the bulk of those cuts with previous two-year budget agreements, in 2013, 2015 and 2018.

Write to Kate Davidson at kate.davidson@wsj.com

(END) Dow Jones Newswires

July 23, 2019 17:49 ET (21:49 GMT)

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