Control of US Senate could inflame political tensions with Obama at expense of economic growth

Markets Associated Press

The midterm slugfest for control of the U.S. Senate could have far-reaching effects on the economy.

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Tuesday's elections come just as U.S. growth has been showing consistent improvement, thanks in part to a congressional truce on budget fights. Previous such fights shut down the government and raised the specter of a default on the federal debt. A repeat of either could damage the economic recovery.

If Democrats retain control of the Senate, the cease-fire could hold, analysts say. But it could dissolve with a takeover that gives Republicans control of both chambers and potentially emboldens them to intensify their conflicts with a lame-duck Democratic White House.

Republicans already control the House and are expected to maintain and even expand their majority in that chamber.

Addressing the prospect of a Republican takeover of the Senate, Jack Ablin, chief investment officer at BMO Private Bank, said, "My sense is it will only harden the tension that's in place."

Though some analysts say Democrats still have a chance to preserve their hold on the Senate, most expect Republicans to capture a narrow majority. This could increase the risk of another prolonged skirmish over taxes and spending. Previous showdowns derailed consumer confidence, the stock market and job growth.

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Still, it remains unclear how Republicans would steer the Senate. Few campaigns have outlined detailed policy agendas. Senate Republicans could repeat past budgetary clashes with renewed vigor. Or they could accept gridlock and pursue smaller deals on less contentious issues involving trade authority with President Barack Obama in hopes of improving their party's fortunes in the 2016 presidential election.

This creates a troubling set of uncertainties for an economy still hobbled in some ways by the resolutions from previous showdowns.

Another budget battle could paralyze businesses and consumers. Yet an eventual congressional deal could prove even more damaging. Previous agreements slowed the economy by raising taxes and slashing funding for military and social programs that can often boost the economy.

The settlements brokered to end clashes in 2011 and 2013 did manage to cut the budget deficit. Yet they subtracted from growth for the past three years, according to Commerce Department figures.

Coupled with the end of stimulus spending from the Great Recession, the automatic spending cuts agreed to three years ago caused government spending to fall relative to the economy. That was followed in 2013 by higher tax rates, which also slowed growth.

As a result, growth has meandered at a sluggish annual pace of roughly 2 percent for three years. Government austerity subtracted 1.9 percent from growth last year, according to Commerce. If the impact of the government had been neutral, the economy would have expanded a robust 4.1 percent last year.

The economic drag from these deals is likely to fade in 2015 and beyond if the current truce holds.

"We're slowly moving away from contracting to stability," said Kevin Logan, chief U.S. economist at the bank HSBC.

The Democrats hold a 55-45 edge in the Senate, meaning that Republicans need a net gain of six seats to take control of the chamber. Many candidates of both parties are running against Obama, whose approval rating has slumped to 41 percent among likely voters compared with 49 percent heading into the 2012 election, according to polling last month by The Associated Press.

In a TV ad in North Carolina, Republican challenger Thom Tillis accused Democratic incumbent Kay Hagan of being a "rubber stamp" for the president. In Kentucky, Democratic challenger Alison Lundergan Grimes has been running against Obama as much as against Republican Senate Minority Leader Mitch McConnell.

Still, few in Congress will have any achievements to celebrate without passing measures that receive Obama's signature. In March, Congress must fund the government and vote on whether to raise or suspend the debt limit.

The 2011 battle over a debt ceiling increase caused financial markets to plunge and triggered a first-ever downgrade in the U.S. credit rating by Standard and Poor's. Economists warned of the threat of another recession. The resulting agreement to raise the government's borrowing authority mandated spending cuts through 2021.

Similarly, the economy was on edge when temporary cuts to income tax rates were on the verge of expiring last year. A battle between Capitol Hill and the White House produced an agreement that avoided a tax hike for everyone by agreeing to raise the top marginal income tax rate. The government shut down for the first half of October 2013, after the House and Senate had failed to approve the legally required spending measures.

Dan Clifton, head of policy research at the analyst firm Strategas, doubts that a Republican-led Senate would choose to fight over the debt ceiling. He expects Republicans to take a symbolic stand on the budget, trying to weaken the Consumer Financial Protection Bureau and defund parts of the Environmental Protection Agency and the Obama health care law.

Clifton said he thinks much of this will amount to posturing that may not cause any destructive spillovers for the economy.

"There is going to be a lot of talk about a government shutdown again," Clifton said. "But I don't think it becomes a reality."

Few expect the gridlock to disappear regardless of Tuesday's outcome. Rather, the question is whether a GOP victory encourages party leaders to challenge Obama or leads them to seek small compromises in the hopes of securing further gains in 2016.

A Republican majority might, for example, vote to authorize Obama to complete trade negotiations for the Trans-Pacific Partnership, which could help exports, said Corey Boles, a senior analyst with the Eurasia Group, a consulting firm.

Regardless of what happens, Boles said voters shouldn't expect the midterms to push Congress into action.

"It will be same personalities in charge of the chambers and a president who is disconnected from domestic policy," he said. "We don't expect a lot to get done."