Government Shutdown: What It Really Means for Your Business - Tom Wheelwright, John Diamond

Key Concepts

• Government Shutdown
• Economic Impact
• SNAP (Supplemental Nutrition Assistance Program)
• Medicaid
• Affordable Care Act (ACA) / Obamacare
• Enhanced Premium Tax Credits
• Budget Deficits
• National Debt
• Inflation
• Fiscal Policy
• Spending Reform
• Tax Reform
• Retirement Age
• Artificial Intelligence (AI)
• Business Adaptability

Government Shutdown and Economic Impacts

The discussion centers on the potential for a record-breaking government shutdown and its economic ramifications, particularly for businesses. While initial assessments suggest limited aggregate impact, the duration and scope of the shutdown significantly influence the severity of consequences.

• Aggregate Impact: The longest previous shutdown (2018-2019) had an estimated permanent economic impact of $3 billion, which was 0.02% of GDP at the time. Short-term impacts were around $11 billion, with much of it being temporary.
• Direct Impact on Individuals: Government employees will experience delayed paychecks, but are expected to receive back pay. However, individuals without savings or access to credit may face significant hardship.
• Impact on Businesses: Businesses directly reliant on government contracts or located in areas with a high concentration of government employees are most vulnerable. The shutdown poses a real burden on these specific private businesses, though not a massive one across the entire economy.

Drivers of the Current Shutdown

The current shutdown is primarily driven by disagreements over the extension of enhanced premium tax credits under the Affordable Care Act (ACA) and the reversal of certain work requirements in healthcare provisions.

• Enhanced Premium Tax Credits: These credits, originally enhanced post-pandemic and extended through subsequent legislation, are set to expire at the end of the year. Both enhancements were passed with solely Democratic votes.
  • Cost: The extension of these credits is estimated to cost $360 billion over 10 years, increasing the deficit.
  • Democratic Goal: Democrats aim to use the shutdown as leverage to secure the extension of these credits, which they argue benefit middle-income individuals, including those in "red states" that have not expanded Medicaid.
• Work Requirements: Democrats also seek to undo savings achieved by implementing work requirements for certain healthcare provisions.
• Total Democratic Ask: The combined requests from Democrats, including the enhanced credits and other provisions, amount to approximately $1.5 trillion over 10 years. This is noted as an unprecedentedly large ask during a shutdown compared to previous instances, such as Donald Trump's border wall request.

Consequences of Funding Lapses

The lapse in government funding has direct and immediate consequences for essential programs and services.

• SNAP (Supplemental Nutrition Assistance Program): A significant concern is the potential halt of SNAP payments. In Arizona, an estimated 900,000 people (nearly 20% of the population) could be affected by a lack of SNAP benefits in November. This highlights how policy arguments unrelated to SNAP directly impact vulnerable populations.
• Essential Services: While "essential services" continue, the personnel involved are not being paid.
  • Air Traffic Controllers: Secretary of Transportation stated that prior to the shutdown, about 5% of air traffic delays were due to personnel issues. This figure rose to 53% as of the recording date, with projections of significant chaos in the air traffic system if the shutdown continues for another two weeks. The inability to work without pay will eventually force individuals to seek other employment.
• Travel and Business Impact: The disruption to air travel, due to understaffed air traffic control, can significantly impact businesses that rely on travel.

Escalating Economic Pain and Shutdown Duration

The economic impacts of a government shutdown are not linear; they escalate with duration.

• November 1st Threshold: The economic pain is expected to significantly increase starting November 1st when SNAP payments cease.
• Compounding Effects: A shutdown exceeding 35 days (the previous record) will see effects build upon each other, potentially altering initial assessments of limited impact. A 60-day shutdown is estimated to be more than twice as severe as a 30-day shutdown.
• Catalyst for Resolution: The growing economic pain, particularly the missed paychecks for federal employees and the impact on programs like SNAP, is anticipated to increase political pressure and eventually lead to a resolution, likely with Democrats agreeing to discuss the issues after the government reopens.

Fiscal Challenges and Proposed Solutions

The conversation shifts to the broader fiscal challenges facing the government, including budget deficits and national debt, and potential solutions.

• Current Fiscal Situation: The US faces significant fiscal challenges with budget deficits running at 6% of GDP and a national debt of $38 trillion.
• Proposed Spending Reform:
  • Reduce Spending: The primary recommendation is to reduce government spending, aiming to bring it down from the current 23% of GDP to 21-22% of GDP.
  • Target Entitlements: Key areas for spending reduction include entitlement programs like Social Security and Medicare.
  • Increase Retirement Age: A potential solution discussed is increasing the retirement age, similar to reforms in 1983, and potentially indexing it to lifespan.
• Proposed Tax Reform:
  • Maintain Low Marginal Rates: The expert advocates for keeping marginal tax rates low.
  • Eliminate Tax Expenditures: Instead of raising rates, the focus should be on eliminating "spending in the tax system" (tax expenditures) to increase revenues.
  • Specific Examples: Suggestions include reducing the child tax credit and eliminating the state and local income tax deduction, which is criticized as poor tax policy. The deduction for property taxes, being a regressive tax, is seen as more justifiable than income tax deductions.
• Revenue Goals: The aim is to bring revenues up to 18-19% of GDP, creating a balance where spending is around 21-22% and revenues are around 19%.

Addressing Middle-Class Concerns and Healthcare Costs

The discussion acknowledges the struggles of the middle class and the rising cost of healthcare.

• ACA Premium Increases: Some ACA plans are projected to increase by 400% next year, creating significant financial strain.
• Equitable Treatment: A point of contention is the differential treatment of retired couples earning $120,000 who receive substantial healthcare subsidies versus working individuals in similar financial situations facing rising employer-sponsored insurance premiums. The argument is made for cutting expenditures that disproportionately benefit those with higher incomes, particularly in retirement.

The Role of AI and Future Taxation

The conversation touches upon the evolving economy and its implications for taxation.

• AI's Impact on Labor: Artificial intelligence and robotics are expected to reduce the need for human labor in many sectors.
• Shifting Tax Base: This trend raises questions about the future of wage income and the potential need to shift the tax base from wages to capital or other forms of income as AI and technology become more dominant. The historical shift from exempting wages to taxing them heavily is noted as a precedent for potential future changes.

Advice for Business Owners Amidst Uncertainty

The expert offers advice for business owners navigating a landscape of constant change and uncertainty.

• Sit Tight and Observe: The primary recommendation is to "sit tight" and observe the unfolding situation rather than making hasty changes based on potentially transient policies.
• Maximum Flexibility: Business owners should focus on maintaining maximum flexibility in their operations and financial strategies.
• Adaptability Over Pivoting: While "pivoting" was a common term during COVID, the current environment requires a focus on adaptability and long-term strategic thinking, especially concerning technological advancements like AI.
• Tax Strategy: From a tax perspective, flexibility involves adapting tax strategies and operational structures to navigate changing regulations.

Further Information

• John Diamond: Can be found at the Baker Institute (bakerinstitute.org).
• Podcast: "The Two-Handed Economist" is available through the Baker Institute.
• Research: Most of his research is available online at bakerinstitute.org.

Conclusion

The government shutdown presents a complex interplay of political demands, economic consequences, and long-term fiscal challenges. While initial impacts may seem limited, the duration and scope of the shutdown, coupled with the cessation of vital programs like SNAP, can lead to significant economic pain. Addressing the nation's fiscal health requires a comprehensive approach involving both spending reform and tax reform, with a focus on sustainability and equitable treatment. Business owners are advised to prioritize adaptability and flexibility in the face of ongoing uncertainty.