Implications of the House budget resolution for consumer credit

Steven Abrahams | February 28, 2025

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.

The House budget resolution for 2025, passed in the last week, offers the first roadmap for the new administration’s fiscal program. It targets $4.8 trillion in tax cuts and new spending over the next decade and $2 trillion in program cuts. Although all households will likely benefit from the tax cuts, those likely get overwhelmed at the low end of the income distribution by cuts in federal programs. The House and Senate still need to work out important details. But for investors in consumer credit, credit quality under the targeted program should strengthen marginally in prime credits and weaken in subprime.

High earners pay most taxes, low earners get most benefits

Most taxes get paid by households at the high end of the income distribution, and the benefits of most federal programs—Medicaid and Medicare, food stamps, subsidized school lunches, early childhood education programs and student lending, among others—go to households at the low end. Cuts and taxes and cuts in federal spending consequently fall differently along the income distribution.

A recent study by the Congressional Budget Office shows that from 2019 to 2021, a substantial part of income for households in the lowest 20% of the income distribution came from federal benefits. In 2019, for example, the last year before Covid programs, the average household in the lowest 20% made $41,500 (Exhibit 1). Of that, $25,200 came from income before taxes and means-tested federal transfers and $16,300 came after (Exhibit 1). At the other extreme, the average household in the highest 20% of income that year made $267,200. Of that, $351,500 in gross income came from labor and other earnings and $84,300 went largely to pay taxes. Similar patterns held in 2020 and 2021, according to the CBO study, and presumably hold today. In absolute amounts, low-income households are net receivers from the federal government, high-income households are net payers.

Exhibit 1: Low-income households net received from the federal government in 2019, high income household net paid to the federal government

Source: Congressional Budget Office, Santander US Capital Markets

Putting absolute amounts into percentage of net income shows more clearly that lower-income households depend on federal programs. In 2019, 61% of income in the lowest tier came from labor and other earnings and 39% from means-tested federal benefits (Exhibit 2). For the highest earners, labor and other income made up 132% of average household net income, while taxes reduced that by 32%. After Covid programs ramped up fiscal transfers to all households, the share of income from federal programs for the lowest tier of earners in 2020 jumped to 53% and in 2021 to 54%. For various reasons, the impact of taxes on the highest tier was relatively steady.

Exhibit 2: Low-income households receive a high share of their income from federal programs, high-income household pay a lower share

Source: Congressional Budget Office, Santander US Capital Markets

The significant federal transfers to households starting in 2020 and reflected in the CBO study coincided with a wide range of developments in consumer credit, including significant declines in delinquencies in mortgages, auto and credit card loans. The distribution of consumer credit scores also drifted higher. Of course, improving credit also likely reflected other efforts to support the economy in general as well as the rising price of homes and autos and a tight labor market with plentiful jobs. As pandemic support programs have tapered off over the last few years and as the Fed has tightened financial conditions, delinquencies have slowly gone up.

The House budget resolution points to key spending cuts

The House in the last week passed a budget resolution for fiscal year 2025 that gives the first clues about targets for spending, revenue, debt and deficits for the next 10 years. That roadmap points to tax cuts as well as cuts to programs with significant benefits for the lowest tier of earnings. Just as important, passing the resolution allows the budget to move ahead through a special reconciliation process. Reconciliation avoids the 60 votes needed to shut down a Senate filibuster and lets the budget pass with a simple majority. The thin majority in the House may still complicate its ability to follow the roadmap. Nevertheless, this paves the way for the Republican fiscal program.

The resolution targets $4.8 trillion in combined tax cuts and spending increases and $2 trillion in spending cuts. That leaves a budgeted net increase in the federal deficit of $2.8 trillion. The House now has to write the details of the budget, reconcile it with the Senate version and pass a final bill.

Most of the impact of tax cuts is arguably already reflected in current household income. The cuts come from extending provisions of the Tax Cuts and Jobs Act of 2017 scheduled to expire this year. The way the federal government scores legislation, taxes would have gone up starting in 2026. Under the House proposal, they will not, hence, tax cuts. It is possible that the House could consider eliminating taxes on tips, overtime and Social Security, among other things, all advertised during the presidential campaign last year. But absent these additional cuts, household tax burdens may not change much next year and beyond.

As for spending cuts, a special set of reconciliation instructions shows the House’s direction of travel. The resolution asks 10 House committees to propose bills to either cut or raise the deficit, although this does not preclude other cuts or increases as the process rolls on (Exhibit 3). The biggest cuts come in a few areas:

• $880 billion in programs under the jurisdiction of Energy and Commerce, which includes Medicare and Medicaid
• $330 billion in programs under the jurisdiction of Education and Workforce, which includes student lending and school nutrition
• $230 billion in programs under the jurisdiction of Agriculture, which includes SNAP, also known as food stamps, and crop insurance
• $500 billion in programs under the jurisdiction of unspecified committees, which could mean the cuts from the named committees get larger

The biggest increase, a $4.5 trillion increase in the deficit, comes from Ways and Means, which largely reflects the estimated impact of extending the expiring provisions of the Tax and Job Cuts Act of 2017.

Exhibit 3: House FY2025 budget resolution looks for specific cuts and spending

Note: Spending overseen by a committee may reflect overlapping jurisdiction. Reconciliation instructions require committees to report back legislation hitting either a floor of deficit reduction (Cut) or a ceiling of deficit increases (Spend). Cuts or increases are 10-year amounts in $ billion.
Source: Bipartisan Policy Center, New York Times, Penn Wharton, Santander US Capital Markets.

Not necessarily a guarantee of specific program cuts, but likely

The tricky thing about anticipating the impact of the reconciliation instructions is that they do not require the committees to target specific programs or even necessarily cut specific federal transfers. The instructions only make cuts to the biggest spending programs likely, but not guaranteed.

Take the instructions to Energy and Commerce to cut $880 billion, where Medicaid and Medicare become targets. That does not guarantee cuts to those programs, but The New York Times lays out the committee’s limited options to avoid cuts to those programs (Exhibit 4). The committee could cut all non-health care spending under its jurisdiction, for instance, and reduce the deficit by $280 billion. Taken all together, the options could produce $467 billion in deficit reduction but would still leave the committee $413 billion short of target. At that point, cuts to Medicaid become highly likely and Medicare comes into view.

Exhibit 4: Avoiding cuts to Medicare, Medicaid falls short of resolution target

Note: All figures over 10 years.
Source: The New York Times, Santander US Capital Markets.

The committee could also choose to restructure aspects of the health care programs. One of the least controversial proposals would add a work requirement to Medicaid for adults without disabilities or young children, estimated to save $100 billion. Studies of Medicaid work requirements show mixed results. Nevertheless, the committee would still end up short of target.

Unclear that growth will offset program cuts

It is theoretically possible that tax cuts could unleash significant capital investment and growth, providing jobs and lifting wages to offset the impact of cuts in federal programs. The record from the TCJA of 2017, however, is mixed. GDP did grow faster after TCJA, but that could have reflected increased spending after the tax cuts—a demand-side lift—as well as changes in oil prices and shifts in monetary, fiscal and trade policy. Real business fixed investment did grow faster after TCJA but peaked at the end of 2017, roughly when TCJA passed Congress, and stayed elevated only through the first quarter of 2018, suggesting it was motivated by things other than TCJA. And most of the investment growth came in oil and mining, with other business sectors less responsive. The rate of new business formation relative to prior years also fell in 2018 and 2019. A Brookings Institution study argues that “the supply-side reaction to TCJA was at best muted and is likely to have been vanishingly small.”

The University of Pennsylvania’s Wharton School has run initial estimates of the economic impact of the House 2025 budget resolution along with its impact on household income. It concludes that “even with economic growth, lower income households are worse off if mandatory spending cuts…are allocated to programs like Medicaid and SNAP.”

Weaker credits already show signs of pressure

If the 2025 federal budget does cut benefits to the lower income tier, it will land in a market where the credit of the weakest borrowers is already eroding. Even though home prices have generally appreciated and current 4% unemployment is still low by historic standards, delinquencies in loans guaranteed by the Federal Housing Administration have accelerated especially in the last six months (Exhibit 5). At the same time, delinquencies among stronger Fannie Mae and Freddie Mac borrowers have not accelerated.

Exhibit 5: Serious delinquencies in FHA borrowers have accelerated

Source: Ginnie Mae, Santander US Capital Markets

Auto delinquencies also have continued to rise, especially among borrowers with the lowest credit scores (Exhibit 6). Low credit score is not a direct measure of income, but likely correlated. Auto delinquencies dropped substantially in 2020, 2021 and 2022 likely because significant government pandemic benefits improved household cash flow and because the rising price of used cars discouraged delinquency. As the programs have lapsed and as used car prices initially declined and then flattened out, credit pressure has increased.

Exhibit 6: New auto loan delinquencies have gone up especially for weaker credits

Note: Data shows delinquencies by credit score at time of origination.
Source: NY Fed Consumer Credit Panel/Equifax, using Philadelphia Fed auto loan tradeline data.

Connecting dots between income tiers and program cuts

The ideal piece of work here would connect a few dots:

• Specific federal program cuts
• Impact on households at different tiers of income
• The presence of household affected by cuts in specific debt instruments

That piece of work will have to wait at least until the House and Senate pass their final budget, although details should start to emerge along the way.

At this point, it looks like tax cuts should add to net income all along the income distribution, but especially for the top 10% that currently pay about 70% of all federal taxes. Spending cuts look likely to have most impact on the lowest tiers of income.

As for the securities most affected, prime jumbo mortgage credit along with prime autos and cards look likely to get the most lift, although these credits already are strong. At the other end of the distribution, subprime cards and subprime auto and unsecured consumer loans look most vulnerable. The balance sheets of those lower-income households are fragile. A small change in medical costs, food budgets or childcare could easily tip them into delinquency.

* * *

The view in rates

The biggest change in the last week has come in real rates, with the 10-year real rate, for example, down 17 bp. A healthy share of the drop came after the House passed the fiscal year 2025 budget resolution on February 25 targeting $4.8 trillion in tax cuts and new spending and $2 trillion in cuts to current programs. For now, the drop in real rate suggests the market sees the fiscal program as a risk to growth. The House and Senate still need to work out details, so that could change.

The market this week also moved from pricing in two cuts in 2025 to pricing in three, which could also reflect risk of weaker growth, But the significant jump in consumer inflation expectations in January should give the Fed pause. Consumer expectations for price increases in the next five to 10 years hit 3.5% in January, the highest since April 1995. The Fed likes to keep inflation expectations anchored around 2%, and, although only one report, the January numbers may ring alarms.

Beyond 2025, the market now lines up with the dots at the end of 2026 and 53 bp above the dots at the end of 2027.  The futures market that far out is admittedly less liquid, but still a signal of skepticism about the Fed’s ability to keep rates down.

With pending tariffs, changes in immigration policy and an active battle underway in Congress over federal spending, the range of potential paths next year for the Fed has expanded. Rate volatility has jumped higher in the last week. It still has room to go higher.

Other key market levels:

• Fed RRP balances closed at $234 billion as of Friday, up $165 billion in the last week. With RRP at 4.25%, Treasury repo at 4.40% and MBS repo at 4.44%, cash has much better alternatives than RRP. The surprising jump in RRP balances suggests limits on repo at banks or other private counterparties.
• Setting on 3-month term SOFR closed Friday at 332 bp, unchanged on the week.
• Further out the curve, the 2-year note traded Friday at 3.99%, down 21 bp in the last week. The 10-year note traded at 4.21%, down 21 bp in the last week.
• The Treasury yield curve traded Friday with 2s10s at 22 bp, flatter by 1 bp in the last week. The 5s30s traded Friday at 47 bp, steeper by 6 bp over the same period
• Breakeven 10-year inflation traded Friday at 237 bp, down 5 bp in the last 1week. The 10-year real rate finished the week at 284 bp, down 17 bp in the last week.

The view in spreads

At the Structured Finance Association conference in Las Vegas this week, interest in credit continued but with notes of caution. Spreads in many corners of the corporate and structured credit markets stand near, at or below the tightest levels in a decade or more. Tariffs, government layoffs and the new administrations fiscal plan may be giving credit investors pause.

The Bloomberg US investment grade corporate bond index OAS traded on Friday at 84 bp, wider by 4 bp in the last week. Nominal par 30-year MBS spreads to the blend of 5- and 10-year Treasury yields traded Friday at 132 bp, wider by 2 bp in the last week. Par 30-year MBS TOAS closed Friday at 29 bp, tighter by 2 bp in the last week.

The view in credit

Fundamentals for the average consumer and most corporate credits continue to look stable. Most investment grade corporate and most consumer balance sheets have fixed-rate funding so falling rates have limited immediate effect. Consumer debt service coverage is roughly at 2019 levels. However, serious delinquencies in FHA mortgages and in credit cards held by consumers with the lowest credit scores have been accelerating. Consumers in the lowest tier of income look vulnerable. The balance sheets of smaller companies show signs of rising leverage and lower operating margins. Leveraged loans also are showing signs of stress, with the combination of payment defaults and liability management exercises, or LMEs, often pursued instead of bankruptcy, back to 2020 post-Covid peaks. If the Fed only eases slowly this year, fewer leveraged companies will be able to outrun interest rates, and signs of stress should increase. LMEs are very opaque transactions, so a material increase could make important parts of the leveraged loan market hard to evaluate.