There are some interesting comments in the Standard and Poor’s press release announcing the US downgrade. I’ve highlighted a few. They make the point that fixing debt involves increasing revenue – the top level of tax in the case of governments – as well as cutting spending. They also note the US difficulty in reaching a consensus on fiscal policy, and the looming demographic that will drive age-related spending.
We lowered our long-term rating on the U.S. because we believe that the prolonged controversy over raising the statutory debt ceiling and the related fiscal policy debate indicate that further near-term progress containing the growth in public spending, especially on entitlements, or on reaching an agreement on raising revenues is less likely than we previously assumed and will remain a contentious and fitful process.
Republicans and Democrats have only been able to agree to relatively modest savings on discretionary spending while delegating to the Select Committee decisions on more comprehensive measures. It appears that for now, new revenues have dropped down on the menu of policy options.
In our view, the difficulty in framing a consensus on fiscal policy weakens the government’s ability to manage public finances and diverts attention from the debate over how to achieve more balanced and dynamic economic growth in an era of fiscal stringency and private-sector deleveraging (ibid). A new political consensus might (or might not) emerge after the 2012 elections, but we believe that by then, the government debt burden will likely be higher, the needed medium-term fiscal adjustment potentially greater, and the inflection point on the U.S. population’s demographics and other age-related spending drivers closer at hand (see “Global Aging 2011: In The U.S., Going Gray Will Likely Cost Even More Green, Now,” June 21, 2011).
Standard & Poor’s takes no position on the mix of spending and revenue measures that Congress and the Administration might conclude is appropriate for putting the U.S.’s finances on a sustainable footing.
Compared with previous projections, our revised base case scenario now assumes that the 2001 and 2003 tax cuts, due to expire by the end of 2012,
remain in place. We have changed our assumption on this because the majority of Republicans in Congress continue to resist any measure that would raise revenues, a position we believe Congress reinforced by passing the act.
Our revised scenarios also take into account the significant negative revisions to historical GDP data that the Bureau of Economic Analysis
announced on July 29. From our perspective, the effect of these revisions underscores two related points when evaluating the likely debt trajectory of the U.S. government. First, the revisions show that the recent recession was deeper than previously assumed, so the GDP this year is lower than previously thought in both nominal and real terms. Consequently, the debt burden is slightly higher. Second, the revised data highlight the sub-par path of the current economic recovery when compared with rebounds following previous post-war recessions. We believe the sluggish pace of the current economic recovery could be consistent with the experiences of countries that have had financial crises in which the slow process of debt deleveraging in the private sector leads to a persistent drag on demand.
The outlook on the long-term rating is negative. As our downside alternate fiscal scenario illustrates, a higher public debt trajectory than we currently assume could lead us to lower the long-term rating again. On the other hand, as our upside scenario highlights, if the recommendations of the Congressional Joint Select Committee on Deficit Reduction–independently or coupled with other initiatives, such as the lapsing of the 2001 and 2003 tax cuts for high earners–lead to fiscal consolidation measures beyond the minimum mandated, and we believe they are likely to slow the deterioration of the government’s debt dynamics, the long-term rating could stabilize at ‘AA+’.
It’s a pity that our politicians can’t reach a consensus on fiscal policy – on capital gains tax, on superannuation, and on tax cuts for the bottom rather than the top. “Key shrugs off credit warning” is the headline in the Herald . Not much chance there of capital gains tax or removal of tax cuts for the rich, and Key has already ruled out looking at changes to superannuation while he is Prime Minister. And after three years of his promising growth is just around the corner the optimistic forecasts in the Budget are now looking less and less likely.
New Zealand is on credit watch negative too. Labour’s long-term plan to tax capital gain rather than sell assets looks more and more credible.