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Congress reaches new lows in latest budget battle

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Even Dr. Seuss would have had a hard time imagining just how absurd the latest congressional budget debate has become.

With lawmakers on the verge of putting the U.S. government out of business for the third time in as many years, the latest budget battle has veered even further off course than past efforts to drive the government off a fiscal cliff.

Five days before the current $4 trillion funding law expires, the discussion this week devolved into a 21-hour diatribe by Texas Republican Sen. Ted Cruz on the sweeping health-care law that begins providing coverage next month to millions of uninsured Americans.

"When Americans tried it, they discovered they did not like green eggs and ham and they did not like Obamacare either," Cruz said Wednesday. "They did not like Obamacare in a box, with a fox, in a house or with a mouse. It is not working."

Neither is the ongoing effort to bring the government's revenues and spending back into balance. About the only remaining source of agreement is the grim outlook if Congress doesn't fix the way the government spends the taxes it collects.

"The bottom line remains the same as it was last year," Douglas Elmendorf, head of the Congressional Budget Office, told a news conference last week. "The federal budget is on a course that cannot be sustained indefinitely."

(Read more: All eyes on House GOP as fiscal deadline nears)

The CBO offered a glimmer of hope in its latest budget assessment, showing a dramatic reduction in the federal budget gap. But the abrupt tax increases and spending cuts have come at the worst possible time as the economy is struggling to grow at 2 percent a year, he said.

The result, say independent budget watchdogs, is that Congress is getting it wrong on two counts.

"You've never come out of a recession with such dramatic deficit reductions," said Josh Gordon, policy director at the Concord Coalition, an independent budget watchdog group. "But very little if any of the short-term deficit reduction is in any way related to preparing for the long-term challenges. It's really bad fiscal policy. "

For the current fiscal year, which ends Oct. 1, the federal government's spending gap shrank by more than a third, to a little over $600 billion from about $1 trillion a year ago. As the economy has grown, the deficit has also fallen in relation to gross domestic product—a widely used benchmark of spending policy.

Part of the improvement comes from this year's compromise package of tax hikes and spending cuts, which slowed the growth of federal spending by $85 billion (and it is set to trim another $20 billion for the next fiscal year beginning in October).

The rest was a series of more or less of lucky breaks, including one-time windfalls that were hard to see coming. The Treasury, for example, saw a surge in taxes late last year as investors booked profits to duck this year's increase in capital gains tax rate. Uncle Sam also got a surprise, a one-time dividend from mortgage giants Fannie Mae and Freddie Mac, which had been all but left for dead.

Democrats have proposed closing the budget gap with additional tax increases, which have been a major force driving this year's deficit reduction. But the higher payroll taxes Congress approved at the start of the year have already proved to be a significant drag on consumer spending, which has held back a stronger economic recovery.

Congress is now left talking about deeper cuts in so-called discretionary spending, which accounts for about 38 cents of every tax dollar, while it is ignoring the most problematic portion of the budget—the other 62 cents of "mandatory" spending on programs like Social Security and Medicare. Those spending levels, of course, are also set by laws approved by Congress. But the programs are too politically popular for even the most ardent budget hawks to tamper with.

The result is that fresh cuts become harder to find and more painful to make; slashing operating budgets slows the economy but does little to defuse the long-term entitlement bomb.

(Read more: Here's who might score if DC shuts down)

The debate on extending those cuts is playing out as fresh data show the U.S. economy still struggling to get back on its feet five years after one of the deepest recessions in a century. The CBO recently estimated that the current deficit-cutting plan, enacted in 2011, will shave another $104 billion over the next 12 months, clipping about 0.7 percent from annual GDP growth at a cost of about 900,000 new jobs. Those cuts will help shrink the deficit even further—from around 4 percent of GDP this year to 2 percent in 2015, the CBO estimates.

To fully balance the discretionary portion of the budget, Congress would have to slash roughly seven times the already painful "sequester" cuts or the equivalent or nearly 4 percent of GDP. Cuts that deep would quickly send the economy hard into reverse.

No matter how deep, those short-term spending cuts do nothing to bend the longer-term, rising deficit as the aging baby boom generation draws more heavily on Social Security and Medicare funds. CBO projects that with no changes in those programs, the deficit will reach almost 3.5 percent of GDP by 2023 and hit 6.4 percent by 2038.

House Republicans holding the budget debate hostage in a last-ditch effort to cut funding for the Obama administration's health-care plan argue that it's yet another budget-busting entitlement program. Ironically, the plan could eventually help curb the deficit by slowing the rise in future health-care spending.

(Read more: Gov't shutdown playbook: Cramer's top 'tell')

The law's supporters argue that much of the cost of covering those who aren't now insured will paid by employers or beneficiaries—not the government. They also note that—whether or not the new law is working—health-care spending has fallen sharply since the Great Recession.

In any case, the true impact of the law is all but impossible to predict—because much depends on how many people sign up, what kinds of coverage employers decide to offer and how much of the cost companies decide to shift to newly insured workers.

Republicans opponents will also have to weigh the political cost of trying to kill the new health-care law. Voters apparently like the program—at least before they've had a chance to see how the details unfold, according to a recent NBC/Wall Street Journal poll. Fewer than 1 in 5 Americans said they think it's worth shutting down the government to kill the plan.

But opinion polls don't seem to be having the usual impact.

"For the Republicans who want to go over the cliff, there's really no downside for them," said David Blitzer, head of the S&P Index Committee. "They're confident they'll get re-elected no matter what happens. It's a strange situation where the forces to pull people back together are not there."

The last two budget standoffs have rattled financial markets and unsettled consumers. But so far, the latest fiscal theatrics seem to have had little impact. That may be because the country has become numb to the threat of a government shutdown, according to Nicholas Colas, of ConvergEx Group.

"We have seen many, many of these debates over many years, we've survived them all. It's not very pretty while it happens but I think markets increasingly understand it's the state of play in Washington, and it's not going to change anytime soon."

Or it may be that the latest fiscal follies are just too ridiculous to take seriously.

"It is a pretty infantile level of discussion," said David Kelly, chief global strategist at JPMorgan Funds.

—By CNBC's John W. Schoen. Follow him on Twitter @johnwschoen.

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