America is on Track for Downgrade Day
From: FT.com
March 31, 2010
The Obama administration is planning to downgrade America. Now, that might seem harsh or unfair, but it is the inevitable conclusion of comparing the Obama budget with the standards for credit downgrades.
The Congressional Budget Office has just released its assessment of the administration’s budget outlook. The numbers are shocking. Under the president’s policies the federal deficit will exceed $700bn (€520bn, £467bn) in every year over the next decade. The sea of red ink will more than double the national debt to more than $20,000bn. The upshot is that in 2020, the deficit is projected to be $1,200bn, of which more than $900bn is borrowing to pay interest on previous debt. It is a sorry state of affairs.
But the numbers that are even more important turn out to be the future path of interest payments and revenues. As outlined in its recent report, the credit rating agency Moody’s looks at the fraction of federal revenues dedicated to paying interest as a key metric for retaining a triple-A rating. Specifically, the large, creditworthy sovereign borrowers are expected to devote less than 10 per cent of their revenues to paying interest. Moody’s grants the US extra wiggle-room based on its judgment that the US has a strong ability to repair its condition after a bad shock. The upshot: no downgrade until interest equals 14 per cent of revenues.
Let’s party ‘til 2014 because in the Obama administration budget, D-Day (Downgrade Day) is 2015 when the magic number reaches 14.8 per cent. Moreover, the plan is not merely to flirt with modest deterioration in creditworthiness. In 2020, the ratio reaches 20.1 per cent. The US is on track for a junk-bond bonanza.
In the aftermath of the bitter healthcare fight, one might be concerned that the new legislation will not live up to its advertisement and instead accelerate D-Day. There are good reasons to be sceptical about the new law, but because most of the budgetary action is after 2014, D-Day is essentially unaltered.
To be fair, the budget also proposed, and the president created via an executive order, the National Commission on Fiscal Responsibility and Reform. Its mission is to provide recommendations that would balance the non-interest deficit by 2015. Won’t that stave off the problem?
At one extreme, the Commission could propose to ramp up revenues at a rate of more than 12 per cent a year. This does stave off D-Day, at least on paper. But very quickly the tax burden becomes unconscionably large – more than 22 per cent of gross domestic product in 2016 – and economically damaging. CBO’s report documents the already rising marginal tax rates on capital and labour income in the administration’s plan, and shows the economic damage of high taxes and high deficits over the long term. The non-partisan Tax Policy Center’s scholars, Rosanne Altshuler, Katherine Lim and Roberton Williams, have a revealing paper that shows the administration’s favourite option – soak the rich – would require that the top two tax rates be raised to 91 and 86 per cent, respectively. This ignores behavioural responses, so even the unhinged Keynesians will acknowledge that soak-the-rich plans take the US over the peak of the Laffer curve and are not really an option.
The best way to hit the target would be to control the growth of spending. After all, the budget outlook is not starved of revenues. The CBO projects that, during the next decade, the economy will fully recover and revenues will be 19.6 per cent of GDP – more than $300bn above the historic norm. Instead, the problem is that spending. Federal outlays in 2020 are expected to be 25.2 per cent of GDP – about $1,200bn higher than the 20 per cent that has been business as usual in the postwar era.
Given the recent binge in spending, curtailing outlays is the way to go, but would require a Herculean political effort. If spending growth were held to 0.55 per cent – essentially an overall freeze – the deficit target would be reached. If the discipline was extended, D-Day would be pushed off . . . to 2016. The spending explosion has been so dramatic it is difficult to unwind.
But there is hope in this approach. After reaching a high of 14.6 per cent, the interest fraction begins to fall. If the US credibly commits to controlling spending, a rating agency looking forward might not pull the trigger on a downgrade. Congress needs to adopt this attitude immediately. No extensions of supposedly “temporary” stimulus spending programmes. No new “jobs” programmes. It is time to use resources wisely and live within the current budget for the foreseeable future.
The Obama plan is a plan for national decline. It is a plan that would undermine the ability to fund a strong military and betray the legacy of the real D-Day. America must instead reclaim its greatness by returning to limited government; reliance on personal liberties and private enterprise; and security through strength.
