The warning tremors that might presage a major US fiscal crisis began today. A major credit rating agency, Moody’s, wrote of the current US fiscal projections: “If such a trajectory were to materialize, there would at some point be downward pressure on the triple A rating of the federal government.”
What does this mean? In some ways, this language is very soft. It reminds me of reading Fed releases from Greenspan. But between the lines is a threat to the lifeblood of our Federal, State, and Local governments, as well as the current housing market. We are currently not taxing enough to cover spending and so are borrowing at enormous rates (implicitly and explicitly). If this ability to borrow goes away or becomes much more expensive, then we suddenly have to balance our budget, which right now would require some combination of a large painful tax hikes and large spending cuts. Concisely, if our debt gets downgraded, this will lead to higher interest rates and the danger of our investor selves forcing our government selves to slash spending and raise taxes.
So what to do? Well, we could fix the deficit now – raise taxes and cut spending. But many economists argue that this is not the time to cut back on government spending or raise taxes. A cut now they say would be like the decline in government spending in the latter half of the 1930’s that lead to the Roosevelt recession. Currently, like in 1936, there are plenty of signs of imminent recovery, but the key word is “imminent,” not “current rapid.” I am not sure if this argument is right or not, but since we do not completely understand the economic world in which we live, it seems to me that one has to consider the reasonable chance that this is correct.
What sort of changes would be needed to balance the budget? Unfortunately, quite significant ones. You see, there actually have been very few tax cuts and very little increases in government transfers and purchases of goods and services in this recession. The headline news of Federal expansions ignores the cuts from states and localities. So on net, and contrary to popular wisdom, we have not had much fiscal expansion. What we have is a long-term problem, as well as a current one. Given reasonable projections for economic growth, we have a long-term fiscal imbalance – we are not taxing enough to cover our spending on defense, Social Security and Medicare, never mind infrastructure, science, education, anti-poverty programs, public health, etc. To balance the budget involves addressing our long-term imbalances, ignored since we got tired of hearing about Al Gore’s lockbox.
The important thing to see is that this is the bad news and the good news. The bad news is the long-term problem. And it is this bad news that caused Moody’s – which missed the housing crisis entirely – to start warning about US government default risk. The good news is that it is the long-term fiscal imbalances that got Moody’s attention. To reduce the risk of downgrade we do not have to cut now. We need instead a reasonable, honest, legislated path to solvency. We need a plan that works and that can pass and that we can reasonably be expected to stick to.
Can this happen? Maybe, maybe not. Certainly Congress’ inability to agree on anything hurts the chances. And any plan would have to cut sacred cows like Social Security, Medicare, defense, almost everything or raise significant taxes. A compromise would probably cut spending and raise taxes.
Isn’t there anything else we can do? Well, during Reagan, Bush, Bush, and now Obama, we have accumulated about $100,000 in Federal debt per US Federal tax return (I am ignoring promised Social Security and Medicare benefits). So, now we owe money. A lot. We can ignore it and hope to grow our way out of it. But if we do not grow our way out, the longer we wait, the greater the pain.
So, keep an eye on President Obama’s fiscal commission. And to start you on your journey to being a more informed economist and/or investor and/or citizen: 1) here is the link to an honest menu of money saving measures, the latest CBO budget options; 2) a “call to action” with few details from the Pew Foundation; 3) here is a solution by Paul Ryan that gets rid of Medicare; 4) or, Isabelle Sawhil’s politically feasible approach of letting the Bush tax cuts expire (as Bush legislated because of the bad long-term budgetary implications of his plan). This should get you started J