James Pethokoukis

Politics and policy from inside Washington

Resisting the Gang of Six budget temptation

Jul 21, 2011 15:04 UTC

America needs to raise its debt ceiling,  cut spending and implement wide-ranging tax reform. The Gang of Six plan claims to do all those things as it reduces debt by close to $4 trillion over a decade. If I could summarize my opposition in one sentence, it would be this one from Rep. Paul Ryan: “The plan appears to increase revenues by $2.8 trillion, without addressing unsustainable health care spending that is driving our debt problems.”

Not enough? Well, Keith Hennessey,  head of the National Economic Council under President George W. Bush, offers a detailed dismantling of the G6 proposal.

I strongly oppose the Gang of Six plan. I think it is absolutely terrible fiscal policy.

First I’ll flag a few things I like in the plan.

  • I support making a technical correction to CPI, even though it would result in higher revenues.
  • Repeal of the CLASS Act is great.
  • It’s good they included medical malpractice reform.

That’s it. Others right-of-center are salivating at the low marginal income tax rates described in the plan, both for individuals and corporations. I think those low rates never materialize, for both arithmetic and legislative reasons, and explain why below.

Read the whole thing but are some key points:

1. It provides no discretionary spending totals.

2. It cuts defense spending while hiding the ball on nondefense spending.

3. The promised deficit reduction is both overstated and less than is needed.

Their $3.7 trillion of claimed deficit reduction is bogus. It includes an unspecified amount of savings from a future legislative fast-track process that would require further Congressional and Presidential action if health spending growth exceeds a certain target.

The Gang’s plan also uses at least three different baselines in different parts of the document. Combine that with the absence of discretionary spending totals and I have no confidence in their $3.7 trillion deficit reduction number.

4. It is a huge net tax increase.

The Gang of Six plan would increase taxes by $2.3 trillion over the next 10 years relative to current policy. That’s roughly a 6.5 percent increase in total taxation. Put another way, the Gang of Six plan raises taxes $830 B more than would President Obama’s February budget. To those who like the promise of low statutory tax rates – the benefits of low marginal rates are far outweighed by the increase in average effective rates. This is a massive hidden tax increase.

5. It’s a far worse trade than Bowles-Simpson.

The fundamental trade of the Bowles-Simpson group was higher net taxation in exchange for (huge long-term spending reduction, especially in entitlements + fundamental structural entitlement reform + pro-growth tax reform).

The Gang of Six plan drops the first two elements of that trade, the huge long-term spending reductions and the structural entitlement reforms. It instead purports to offer pro-growth tax reform in exchange for much higher net tax levels. It offers trivial spending cuts, no flattening of long-term entitlement spending trends, and no structural reform to the Big 3 entitlements.

6. It trades a permanent tax increase for only a temporary respite on spending.

The plan proposes permanent increases in net taxation levels in exchange for a temporary slowdown in spending. The entitlement spending line would be shifted ever so slightly downward – there would be no long-term “flattening of the spending curve

The consequence of this would be kicking the can down the road. Deficits would be smaller for the next 5-10 years while the higher tax levels offset entitlement spending growth. But since the plan does nothing to flatten the curve of Social Security, Medicare, or Medicaid spending, 5-10 years from now we will be right back where we are now, but with higher levels of taxation. We will again face huge and growing future deficits, driven by unsustainable entitlement spending growth.

7. It’s an unfair deal on CPI.

8. It precludes structural reforms to Medicare and Medicaid.

The Plan says “while maintaining the basic structure of [Medicare and Medicaid].” That language precludes needed fundamental reforms to these programs, as contemplated in Bowles-Simpson, Rivlin-Ryan, or the House-passed budget resolution.

9. It does almost nothing to slow health spending growth, and even the $115 B of additional health savings are bracketed.

10. It leaves the core trillion dollar ObamaCare health entitlement in place.

11. It makes it harder to do Social Security reform, drops the specific Social Security reforms of Bowles-Simpson and increases Social Security spending.

12. It sets the wrong bar for Social Security reform and tilts reform toward tax increases.

13. It locks in the net tax increase, then hopes to deliver on the stated tax reform policies.

If you are tempted by the promised details of tax reform, remember that those details would be negotiated after the Senate had already committed to a $2.3 trillion tax increase.

Even if I could swallow a $2.3 trillion tax increase, which I can’t, I don’t trust the tax reform process enough to take that risk. The plan offers no procedural guarantees to prevent the tax policies described within it from being ignored by the Senate Finance Committee.

14. It undoes most of the benefits of last December’s tax policy battle.

15. It sets up a tradeoff between marginal income rate cuts and capital tax rates.

The tax reform described in the Gang’s plan is silent on capital taxation. Side conversations suggest the Gang agreed to but did not put on paper a 20% rate for capital gains and dividends. From a pro-growth perspective, lowering marginal income tax rates by raising capital taxation rates is a bad trade. And both the numbers and politics suggest that much of the higher revenues raised from “eliminating tax breaks” would come from higher tax rates on capital rather than scaling back even more popular tax preferences for homeownership, charity, and health insurance.

Lowering the corporate income tax rate is nice, but you get more growth bang for the buck by allowing immediate expensing of investment. If depreciation is treated as a tax expenditure and the lower corporate rates are paid for in part by lengthening depreciation schedules, that will slow growth, not accelerate it.

16. The rate cuts are overpromised because the Gang overestimated the revenue that would be raised from reducing tax expenditures.

I strongly support scaling back or even eliminating most if not all tax preferences. I’d go much further than I could ever get support for from elected Members of Congress. But I want to use the revenue raised from eliminating those tax expenditures to cut rates, not to make spending cuts smaller as the Gang’s plan does.

The Joint Tax Committee warns us that the revenue raised by eliminating a tax preference is less than the measured “tax expenditure,” and often far less, because of the incentive effects. It appears the Gang far overestimated the revenues that would be raised from eliminating tax preferences, and therefore are promising marginal rates they cannot deliver. Those who are attracted by the low promised rates for individual and corporate income should understand that if the revenue raised from eliminating other tax preferences is insufficient, the actual rates in reform will be higher. And that’s assuming you trust a Senate Democratic majority process to deliver the unenforceable tax policy promises described in the Gang’s plan.

Tax experts I trust tell me they can’t see how you could design a tax reform that hits the revenue targets promised (even with a +$2.3T revenue increase) and get statutory rates as low as promised. The revenue raised from “reforming” these preferences won’t be enough to lower rates that much, and repeal the AMT, and move to a territorial system, and reduce deficits.

17. The plan proposes a deficit trigger mechanism that might include automatic tax increases.

 

 

The impact of U.S. credit rating downgrade

Jul 20, 2011 17:22 UTC

It does not appear to be as frightening as I might have assumed. Here is a bit (via Business Insider) from a Goldman Sachs conference call this morning where the impact of a AAA downgrade is discussed

11:23 It has to do with the magnitude of the downgrade. If we went to AA, directionally it would be negative but it’s suprising the modest effect it could have on, IE:

– Money market mutual funds are front of mind when thinking about a downgrade. Reqired to hold 97% of their assets in AAA

In terms of the rating that matters – it’s the short-term rating, not the long-term rating. And the S&P has implied that it would only downgrade the long-term, so money market funds wouldn’t be affected. They hold between 300 and 350 billion in treasuries. Probably not as much of a risk

– Financial sector- banks — didn’t want to be too specific, but under Basel I there wouldn’t be any affect. under basel II, 0-risk to anything AA and above, so not really an issue

The complicated factor comes in with some of the larger firms, there could be a slight uptick in the calculated capital required to be set aside related to holdings. But a very minor change in capital requirements

– Insurers – obvious. those three bring the $ up to $1 trillion

– Pension funds – not much of an issue

11:28 Rest of the question becomes what the rest of the world would do, how much selling, but they might have more flexibility than holders in the U.S.

11:31: On august 3rd we have a social security checks due. On August 15, we have a coupon due. The treasury will have to decide what it will do to make those payments

Perhaps the bigger impact will be political if Obama or Republicans get the bulk of the blame for losing America’s gold-plated credit rating.

 

COMMENT

McBride, your credit works in a similar manner. When you have credit obligations and are paying them, your credit will strengthen. When you stop paying them your credit weakens. Whether you choose to borrow more or not does not impact your credit rating. However, your credit rating will determine how much you are able to borrow. Please make a better effort to understand the current political and economic climates.

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How would U.S. react to a debt crisis?

Jul 20, 2011 17:20 UTC

If the U.S. doesn’t get a handle on federal debt, there will be a financial and economic crisis. By 2035, debt as a share of GDP could be 250 percent, though a panic would surely happen long before that point was reached. But if a crisis came, how would Washington react? What drastic measures would be taken? I think there would be a huge push for a massive tax increase, probably via a value-added tax. Here is some of what the Comeback America Initiative sees happening:

Social Security

• The higher retirement eligibility ages for Social Security would be increased to 70 for normal retirement and 65 for early retirement, and fully implemented by 2030 and 2020, respectively.

Most of the proposed reforms under the Preemptive (Prudent) Framework would be retained with the following significant differences:

• Repeal the Affordable Care Act of 2010.

• Repeal the Medicare Modernization Act of 2003.

Defense:

Most of the illustrative reforms under the Preemptive (Prudent) Framework would be retained with the following significant differences:

• Accelerate the planned draw down of U.S. troops from Southwest Asia from the end of 2014 to the end of 2012.

• Accelerate the reduction of U.S. overseas military and civilian presence.

Taxes and Revenues:

• Impose temporary deficit reduction revenue increases in fiscal 2013-2014 to accelerate deficit reduction and debt/GDP stabilization efforts.

• Phase-in the special income and payroll tax exclusion on employer provided and paid health care by 2018.

• Take any other actions needed to comply with annual revenue targets.

And the result:

The result is a balancing of the total budget by 2015, and reduction of debt/GDP to about 51 percent of GDP in 2021 and declining rapidly, versus about 76 percent of GDP and increasing rapidly under CBO’s current law baseline, and to about 28 percent and declining in 2035 versus about 91 percent and rising under the baseline.  … Overall spending under the framework would be reduced to 20.1 percent of GDP in 2021, from 23.9 percent under the current law baseline, and to 21.8 percent of GDP and leveling in 2035 from 28.3 percent and rising under the baseline. Nominal public debt would be less in 2023 than 2015 and essentially stable.The Reactive (Crisis Management) Framework also involves having to impose a temporary deficit reduction revenue increases to accelerate deficit reduction and debt/GDP stabilization, while maintaining an overall cap on federal revenues at 21.5 percent of GDP

 

COMMENT

Re healthcare – As long as we’re in simplification mode, why not simply put the entire US population into a single risk pool? Then let insurance companies compete for customers and the providers to serve them. As it stands, each state sets its own regulations and the result is that insurers play the system by cherry picking markets, charging higher premiums in states where they can get away with it, and dictating how providers are compensated. Tear down the barriers and prices will fall.

The only thing certain about repealing Romneycare and not replacing it with another plan is that healthcare costs will soar off the charts and ever increasing numbers of people will be denied access.

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Americans still think raising debt ceiling a dodgy idea

Jul 20, 2011 14:34 UTC

These results from a survey by Northwestern’s Kellogg School of Management (via its Financial Trust Index site) are sure to get noticed in Washington:

Why the House GOP will deep six the Gang of Six

Jul 20, 2011 13:33 UTC

Will the House GOP play ball on the Gang of Six debt reduction plan? The Paul Ryan-led House Budget Committee is giving members all the ammo they need to take a pass (bold is mine):

Heavy Reliance on Revenues. The plan claims to increase revenues by $1.2 trillion relative to a “plausible baseline.” It also claims to provide $1.5 trillion in tax relief relative to the CBO March baseline. The CBO baseline assumes the expiration of tax relief, resulting in a $3.5 trillion revenue increase. As a result, the plan appears to include a $2 trillion revenue increase relative to a current policy baseline. If the $800 billion in tax increases from the new health care law are included, the plan appears to increase revenues by $2.8 trillion, without addressing unsustainable health care spending that is driving our debt problems.

Elusive Spending Restraint. It is unclear how much the plan achieves in spending savings. Based on released documents, it appears to primarily rely on cuts in the defense budget through $886 billion in reductions from the President’s budget for “security programs.” In the security category the Gang of Six reduced the security category by $886 billion. Department of Defense (DOD) spending comprises approximately 85% of the security category. The Gang of Six also proposes a firewall that requires this $886 billion is cut from security spending.

Lack of Entitlement Reform. The plan does not address the $1.4 trillion in spending expansions in the new health care law. The health care law increases eligibility for the Medicaid program by one-third and creates a brand new health care entitlement. It does not appear to include reforms to the Medicare program. While it appears to pursue Social Security reform, it could end up creating barriers to enactment of these reforms.

I mean, the stunningly massive tax hike alone is a deal killer, I would think. Now there are some parts Team Ryan seems to like, and maybe they could get added to the McConnell-Reid plan, such as repealing the CLASS Act and various budget reforms. But more than that? I doubt it.

COMMENT

I concur Mr. Pethokoukis. If one considers the ordinary baseline is revenues of 18% of GDP, that would translate into about 2.7 trillion dollars. That is 27 trillion over 10 years. Increasing taxes by 2.8 trillion dollars means an increase of over 10% of all federal tax collections. That is an enormous tax increase in times of good economy and probably a disastrous increase in times of bad economic news. Gallup just came out yesterday with news unemployment in creased in the first half of July. If that persists it means unemployment in early August will increase. Another potential problem few people realize is that the extra 280 billion dollars will probably not come from the “rich”. Recall the expiration of the tax cuts is thought to bring only 70 billion dollars a year. Either we will soak them by increasing their rate not by 4.6% but rather 18.4% or there will be tax increases for all the 53% of people who indeed pay income taxes or a massive increase in corporate taxes.

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Explaining Obama’s tax-hike obsession

Jul 19, 2011 02:41 UTC

It’s the great mystery of the debt ceiling debate: Why is President Barack Obama so darn adamant about raising taxes? “This may bring my presidency down, but I will not yield on this,” Obama told Republicans before dramatically exiting their budget meeting last week.

“This,” of course, is his demand that large spending cuts be “balanced” with tax increases on wealthier Americans, entrepreneurs, investors and unpopular businesses such as Big Oil and Wall Street. But why insist on higher taxes in the middle of weakest economic recovery in the post-World War II era?

Wouldn’t standard Keynesian economics, much beloved in the White House, actually call for cutting taxes (or increasing spending) to boost aggregate demand?

Doesn’t Obama know that even his former chief economist, Christina Romer, says tax increases “will tend to slow the recovery in the near term.” Not that things look much better a few years out. The International Monetary Funds sees economic growth below 3 percent through 2016. And Democrat-friendly Goldman Sachs now thinks a double-dip recession is possible even as it lowers its growth forecast and raises its prediction for unemployment.

But Obama’s tax obsession becomes understandable when you realize the long game he’s playing: Big Taxes to fund Big Government. Decade after decade. See, it’s an almost universal belief among left-of-center journalists, economists, policymakers and politicians that Americans must pay higher taxes in coming years to cover the medical expenses of its aging population – not to mention all sorts of brand new social spending and green “investment.” Dramatically higher taxes. On everybody. And if we have a debt crisis, maybe those tax increases come sooner rather than later.

And it’s not even a secret, really. Here’s liberal economics columnist Ezra Klein of The Washington Post:

The reality is that we’re going to have higher taxes in the coming years, and beyond that, we’re going to have higher taxes than we’ve traditionally had during periods in which taxes were relatively high.

And liberal economics columnist David Leonhardt of The New York Times outlines a completely implausible scenario — at least to himself — to avoid massively higher taxes:

For taxes to remain where they are, Washington would need to end Medicare as we know it, end Social Security as we know it, severely shrink the military – or do some combination of the above.

How high? Three liberal think tanks recently devised budgets to put the U.S. government on a sustainable fiscal path through 2035. Their plans, collectively, called for Washington to collect an average of 23.6 percent of GDP vs. the post-World War II average of 18.5 percent. To put that in further perspective, the highest level of tax revenue that Uncle Sam has ever taken is 20.9 percent in 1944.

And to reach such a stratospheric level of taxation, these groups are calling for unprecedented tax hikes via millionaire surtaxes, higher taxes on alcohol and tobacco, securities transaction taxes, higher taxes on capital gains, higher taxes on corporations, higher death taxes, carbon taxes, and gasoline taxes. None of which, supposedly, would hurt economic growth. Even worse, all those tax hikes would still fail to balance the budget. And when you move past 2035, taxes would almost certainly need to go even higher.

That is the high-tax future the liberal establishment has in store for America. No wonder Obama rejected his own debt commission last December. It would limit the tax and spending burden to 21 percent of GDP. Neither is nearly enough for the Obamacrats and their successors. Just look at Obama’s budget from last February. Over a decade, it never reduces spending to less than 23 percent of GDP and spending is actually higher at the end of the ten-year span than in the middle. And eventually all that spending would need to be paid for via higher taxes. Recall that back in 2009, the White House floated a trial balloon about a instituting a value-added tax to pay for healthcare reform or general debt reduction.

Underlying all this longing for higher taxes is a belief government can’t and shouldn’t be cut. Nonsense. Both the American Enterprise Institute and Heritage Foundation have devised workable fiscal plans that would keep taxes below 20 percent of GDP. And Rep. Paul Ryan’s Path to Prosperity shows how to reduce spending to below 19 percent of GDP by 2040. And rather than managed decline toward a slow-growth, EU-style social welfare state  (that even the EU can’t afford anymore,) these plans would help keep America growing and living standards rising as they have for decades. Those are high stakes in the debt ceiling debate —  and in the battles over taxes and spending in the years to come.

COMMENT

@Dustycornfield, the poor, once deprived of a job, housing and lastly food, will simply eat the rich. They lack good protein in their diets.

@jabone, welfare for the rich and corporations rather than working to move the USA forward is what the Republicans are all about … giving the most to those who do not need it, are what people like you don’t/can’t see.

The propaganda machine that is fox news truly worked its magic on the dimwitted… especially being you blame the Democrats for the “class warfare.”

http://www.nytimes.com/2003/09/14/magazi ne/the-tax-cut-con.html?pagewanted=19&sr c=pm

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Would the GOP’s ‘Cut, Cap and Balance’ plan really cost 700,000 jobs?

Jul 18, 2011 16:24 UTC

This is the Democratic talking point: Cutting spending by $111 billion, as some Republicans want to do, would cost the economy 700,000 jobs.  Now I will admit that I am not sure if those are jobs somehow not created, jobs somehow not saved or what exactly.

But the basic point is that less government spending means fewer jobs. But to believe that, you also have to believe that more government spending means more jobs.  Just ask Moody’s.com economist Mark Zandi who had this to say in February about an earlier GOP plan to cut spending by $61 billion (and is the apparent source of the meme):

The House Republicans’ proposal would reduce 2011 real GDP growth by 0.5% and 2012 growth by 0.2%. This would mean some 400,000 fewer jobs created by the end of 2011 and 700,000 fewer jobs by the end of 2012.

And recall that Zandi had this to say about the Obama’s $800 billion stimulus:

Nonetheless, the effects of the fiscal stimulus alone appear very substantial, raising 2010 real GDP by about 3.4%, holding the unemployment rate about 1½ percentage points lower, and adding almost 2.7 million jobs to U.S. payrolls. These estimates of the fiscal impact are broadly consistent with those made by the CBO and the Obama administration.

I have expressed my doubts about this before, as has economist John Taylor who, after examining data as opposed to models, concludes this about the Obama stimulus (bold is mine):

Individuals and families largely saved the transfers and tax rebates. The federal government increased purchases, but by only an immaterial amount. State and local governments used the stimulus grants to reduce their net borrowing (largely by acquiring more financial assets) rather than to increase expenditures, and they shifted expenditures away from purchases toward transfers. Some argue that the economy would have been worse off without these stimulus packages, but the results do not support that view.

Here is another way of looking at why the stimulus didn’t function as projected — and why the GOP budget cuts wouldn’t hurt the economy:

Unfortunately, we find substantially smaller government spending multipliers than those used by Romer and Bernstein. For example, the multiplier associated with a permanent increase in government spending by the end of 2010 lies between 0.5 and 0.6. In other words, government spending does not induce additional private spending but instead quickly crowds out private consumption and investment.

We also provide an assessment of the impact of the American Recovery and Re-investment Act. This legislation implies measures amounting to $787 billion and spread over 2009 to 2013 but peaking in 2010. Our estimate of the total impact is closer to 1/6 of the effect estimated by Romer and Bernstein. By 2010 we project output to be about 0.65% higher. Using the same rule-of-thumb as Romer and Bernstein, this increase in GDP would translate to about 600,000 additional jobs rather than three to four million.

So if the GOP plan cost any jobs, it might be in the tens of thousands. And that number might be more than offset by massive new hiring caused by the decrease in business and consumer uncertainty. Deep cuts in spending, hard spending caps and a balanced budget amendment would go a long way toward removing the threat of fiscal crisis from the fiscal horizon. If only the EU could say the same right now.

Kill jobs? The GOP plan would potentially be a powerful job creator.

 

 

 

COMMENT

Taking my money and giving some of it back in the form of misguided programs (The presidential dollar coin fiasco comes to mind) can never be more efficient than letting me keep the money and spending it on something that I want or need. The money I keep goes directly into doing something usefull, while the money the government takes always has a pretty high collection and adminitrative costs before it is ever spent. We don’t need the “balanced” approach of tax hikes now and maybe cuts later that the dems are proposing. This will encourage the politicians to get us into even more wars, and to spend ever more money on wastefull give aways as part of their campaign to get re-elected. The cycle of tax and spend needs to be interupted. Keep on writting Mr. Pethoukokis you are correct.

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Panic at the White House? Gloomy Goldman Sachs sees high unemployment, possible recession

Jul 16, 2011 12:22 UTC

Last night in a new report, Democrat-friendly Goldman Sachs dropped an economic bomb on President Obama’s chances for reelection (bold is mine):

Following another week of weak economic data, we have cut our estimates for real GDP growth in the second and third quarter of 2011 to 1.5% and 2.5%, respectively, from 2% and 3.25%. Our forecasts for Q4 and 2012 are under review, but even excluding any further changes we now expect the unemployment rate to come down only modestly to 8¾% at the end of 2012.

The main reason for the downgrade is that the high-frequency information on overall economic activity has continued to fall substantially short of our expectations. … Some of this weakness is undoubtedly related to the disruptions to the supply chain—specifically in the auto sector—following the East Japan earthquake. By our estimates, this disruption has subtracted around ½ percentage point from second-quarter GDP growth. We expect this hit to reverse fully in the next couple of months, and this could add ½ point to third-quarter GDP growth. Moreover, some of the hit from higher energy costs is probably also temporary, as crude prices are down on net over the past three months. But the slowdown of recent months goes well beyond what can be explained with these temporary effects. … final demand growth has slowed to a pace that is typically only seen in recessions. .. Moreover, if the economy returns to recession—not our forecast, but clearly a possibility given the recent numbers …

Alarms bells must be ringing all over Obamaland today. Unemployment on Election Day about where it is right now? Sputtering — if not stalling — economic growth? To many Americans that would sound like the car is back in the ditch — if it was ever out. Maybe Goldman is wrong, but economists across Wall Street have been growing more bearish.

And recall that back in August of 2009, the White House — after having a half year to view the economy and its $800 billion stimulus response — made an astoundingly optimistic forecast. Starting in 2011, with Obamanomics fully in gear and the recession over, growth would take off. GDP would rise 4.3 percent in 2011, followed by … 4.3 percent growth in 2012 and 2013, too!  And 2014? Another year of 4.0 percent growth. Off to the races, America.

Even in its forecast earlier this year, Team Obama said it was looking for 3.5 percent GDP growth in 2012, followed by 4.4 percent in 2013,  4.3 percent in 2014.

Goldman Sachs doesn’t have to tell you things are bad. I don’t have to tell you things are bad. Everybody knows things are bad. Unemployment is at 9.2 percent (11.4 percent if the official labor force hadn’t collapsed since 2008 and 16.2 percent if you include discouraged and underemployed workers.)  Moreover, the economy grew at just 1.9 percent in the first quarter of this year and may have grown less than 2 percent in the second. Wages and income are going nowhere fast.

When will the White House signal a change of economic direction? Will cutting tax rates and regulation ever make it on the agenda? That may be the only way Obama can win another term. And time is running short.

 

COMMENT

Oddly, disliking what Obama and Obamanomics have done to the country doesn’t make you:

racist
unpatriotic (if you were a real patriot you’d just nod and say yes to anything the administration wants to do)
conservative
Republican
Tea Party

It just makes you intelligent. Welcome to the disenfranchised.

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Will coming debt ceiling deal save America’s AAA credit rating?

Jul 15, 2011 11:34 UTC

Keeping America’s gold-plated credit rating may take both a deal to raise the debt ceiling (which will happen) and a meaningful deficit reduction plan of around $4 trillion (which is not happening). Moody’s says it wants a  ”deficit trajectory that leads to stabilization and then decline in the ratios of federal government to GDP and debt to revenue beginning within the next few years.” And here is Standard & Poor’s in a report released last night:

If a debt ceiling agreement does not include a plan that seems likely to us to credibly stabilize the U.S.’ medium-term debt dynamics but the result of the debt ceiling negotiations leads us to believe that such a plan could be negotiated within a few months, all other things unchanged, we expect to affirm both the long- and short-term ratings and assign a negative outlook, If such an agreement is reached, but we do not believe that it likely will stabilize the U.S.’ debt dynamics, we, again all other things unchanged, would expect to lower the long-term ‘AAA rating, affirm the ‘A-1+’ short-term rating, and assign a negative outlook on the long-term rating.

Looking at the most likely scenario out there right now, Goldman Sachs has its doubts (bold is mine):

Using our baseline projections as a starting point, the $1.7trn agreement we outline would represent substantial progress, but would probably fall short of Moody’s criteria. That said, we view any agreement that is reached this year as a first step; tax and entitlement reform efforts look likely following the election in 2013. With a cyclically-adjusted primary deficit of around 6% of GDP in 2011, additional consolidation clearly will be necessary, and thus we view this as the first round of what will ultimately need to be multiple deficit reduction measures over the next few years.

Here is the deal  Goldman is looking at (from its report):

1) An agreement that involves primary deficit reduction of $1.5trn to $1.7trn

2) Roughly $1.1 trillion in savings from the discretionary budget, which would be achieved through spending caps; roughly $350 bn in health-related savings, mainly from Medicare; and around $250bn in savings from other areas of the “mandatory” budget such as agricultural subsidies, federal retirement benefits, and fees charged by the GSEs.

3) $2.4trn debt limit increase structured in a similar manner to what Senate Minority Leader McConnell proposed earlier this week.

4) Our hypothetical agreement assumes that the 2% payroll tax cut will be extended through next year, at a cost of $111bn spread over FY2012 and FY2013, and that that a small amount of “tax expenditures” are eliminated, raising $55bn.

– We assume a package in which a good deal of the total savings occur in the last few years.  …  This assumption, combined with other spending cuts and the tax provisions noted above, results in a roughly budget neutral package in 2012 (as compared with current law), rising to savings excluding interest of nearly $300bn by FY2021. Compared with our own forecast, which assumes a payroll tax cut extension and modest spending cuts in 2012, this would increase the structural deficit reduction we assume by 0.2% to 0.3% of GDP.

Bottom line: “The upshot is that against either our projections or the official baseline projection from CBO, the hypothetical $1.7trn agreement we sketch out would meaningfully reduce the debt-to-GDP ratio over the next ten years. The debt reduction would reduce interest expense by more than $300bn, for a total of around $2trn in deficit reduction. Likewise, it would reduce the primary fiscal balance (i.e. the deficit excluding interest expense) by nearly 1.5% of GDP toward the end of the decade.”

Certainly this will only be the first of many deals, with a much bigger one likely in 2013. Hopefully, the credit raters will take that into account. But certainly it seems as if a loss of the AAA ratings is possible even with a debt ceiling deal. And that would be bad. What might happen? We at Reuters have looked at this:

1) When Moody’s Investors Service revised its outlook on Japan’s AAA-rated sovereign debt to negative from stable in 1998 — similar to what S&P did to the United States on Monday — the yen sank to its lowest level in six years and government bond prices fell sharply.

2) If the dollar did weaken, it could boosts export sales of U.S. manufacturers, but also put upward pressure on inflation by making imports more expensive.

3) The greater threat might be higher borrowing costs if investors demand a greater reward to take on more risk from a less credit-worthy nation. The knock-on effect would be felt in sectors sensitive to interest rates such as housing and automobile sales, both of which were floored by the Great Recession of 2007-2009.

4) Skeptics downplay the significance of a potential S&P downgrade. Tom Porcelli, chief economist at RBC Capital Markets, found that sovereign yields on four countries that lost AAA status actually fell six basis points on average 12 months after a downgrade. However, three of those examples — Spain and Ireland in 2009 and Italy in 1991 — hardly compare to the United States, and the fourth, Japan in 1998, has yet to see significant economic growth.

5) Thomas Lawler of Lawler Economic & Housing Consulting is among those who discount S&P’s negative outlook, saying he would look at hard data on jobs and income for guidance. ”Who cares what they think? These are the same people who rated (subprime) bonds,” Lawler said. “I don’t view it as a BFD — a big financial deal.”

Oh, and 7,000 U.S. municipal ratings might also be downgraded, says Moody’s

Moody’s Investors Service has placed the Aaa bond rating of the government of the United States on review for possible downgrade given the rising possibility that the statutory debt limit will not be raised on a timely basis, leading to a default on U.S. Treasury debt obligations. On June 2, Moody’s had announced that a rating review would be likely in mid July unless there was meaningful progress in negotiations to raise the debt limit.

In conjunction with this action, Moody’s has placed on review for possible downgrade the Aaa ratings of financial institutions directly linked to the U.S. government: Fannie Mae, Freddie Mac, the Federal Home Loan Banks, and the Federal Farm Credit Banks. We have also placed on review for possible downgrade securities either guaranteed by, backed by collateral securities issued by, or otherwise directly linked to the U.S. government or the affected financial institutions.

Not good.

 

 

 

COMMENT

Here is an interesting site (probably not owned by Goldman Sachs):
http://www.usdebtclock.org/

Posted by FBreughel1 | Report as abusive

The roof is on fire! A mid-day debt ceiling update

Jul 14, 2011 17:47 UTC

A brief rundown on what’s happened so far today in the Mother of All Budget Battles,  and what folks are saying about it:

– Obama, lawmakers face fresh doubts on debt deal -Reuters | Key bit in the piece is a warning from JPMorgan CEO Jamie Dimon that a deal needs to get done

– Harry Reid And Mitch McConnell: ‘Hybrid’ Solution To Debt Standoff -HuffPo | Another way of trying to get $1.5 trillion in cuts through Congress.

– Nancy Pelosi, John Boehner reject Camp David – Politico | But it is unclear whether the WH was even going to suggest this.

– Few Americans Fear ‘Economic Catastrophe’ If Debt Ceiling Not Raised: Poll – HuffPo | Just 22 percent, but a lot more bankers and businessmen are extremely worried

– Gang of Six talks heat up as White House debt-limit talks melt down -The Hill |  Can  (now) Big Five pull out a $4 trillion deal? I really doubt it.

Reid slams Cantor – Roll Call | The Majority Leader couldn’t pay enough for great headlines like that one

China urges U.S. to protect creditor by raising debt -NYTimes |  I don’ t think the House GOP are going to be swayed by China’s foreign ministry wants

– S&P: U.S. Debt Could Reach ‘Junk’ Rating by 2030, Absent Entitlement Reform – CNSNews | Actually way before then because there will be a financial crisis if nothing is done.

Mark Dayton offers deal that could end Minnesota shutdown – WaPo | Dem chief exec gives in to GOP legislators. Definitely a must read today on Capitol Hill

Tea party vs. big Business in debt debate — WaPo |  This in an interesting bit:

The problem for McConnell is that the tea party wing of the party isn’t all that interested in giving the GOP nominee the best chance in 2012. It wants cuts, first and foremost, and damn the torpedoes. That’s the attitude the tea party was essentially founded on.

McConnell’s proposal and justifications amount to an acknowledgement that the political endgame has gotten away from the GOP. Whether through any fault of their own or not, Republicans are in a corner when it comes to a default, and as his colleagues suggest, McConnell is ceding major ground.

It’s becoming clear that he can’t please both sides of his party’s new coalition. The question is how it gets resolved, and how deep the wounds will be going forward.

The Great Debt Ceiling Gambit – The Weekly Standard | Tough stuff from Fred Barnes who accuses Obama are pushing a crisis for political gain.

 

 

 

 

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