July 2011

Between a Rock and a Hard Place: S&P's Latest Warning

S&P has followed Moody's in issuing the frequent warning about how not raising the debt ceiling by August 2 will affect the U.S.'s credit rating. With all the political wrangling that is still occurring just three weeks before the scheduled default date, the rating service continues to issue warnings just as it had earlier in the year.

Further delays in raising the debt ceiling could lead us to conclude that a default is more possible than we previously thought. If so, we could lower the long-term rating on the U.S. government this month and leave both the long-term and short-term ratings on CreditWatch with negative implications pending developments.

These continued warnings seem to have further convinced many lawmakers that not raising the debt ceiling will have disastrous consequences. Since the "big deal" of $4 trillion does not seem to be possible at this point (despite the President's continued push for it in today's press conference), leaders have been discussing alternatives: a $2 trillion deal, a mini-mini deal, or the plan proposed by Senate Minority Leader Mitch McConnell to allow the President to raise the debt ceiling himself. But this is where it gets tricky. S&P is also warning that if lawmakers do not enact a $4 trillion deficit reduction plan, they will not consider the medium-term debt problem to be sufficiently solved and may downgrade the US's rating this year even if the debt ceiling is raised in time.

We may lower the long-term rating on the U.S. by one or more notches into the 'AA' category in the next three months, if we conclude that Congress and the Administration have not achieved a credible solution to the rising U.S. government debt burden and are not likely to achieve one in the foreseeable future.

They mention a few times in their rating that $4 trillion is their benchmark for a successful and credible deficit reduction plan. It seems that if any of the other alternatives accompanies a debt ceiling increase, S&P may still be looking to downgrade the US in the near future. Not a good sign, considering where the current debt ceiling negotiations are.

Right now, we are between a rock and a hard place. If we don't raise the debt ceiling on time, we would default on some of our obligations and would certainly be downgraded by S&P and other rating agencies. If we don't enact a $4 trillion plan, we would likely get downgraded by S&P within a few months. Looks like raising the debt ceiling and putting in place a $4 trillion plan is the way to go. 

CNN EXCLUSIVE: Don't give up on grand bargain on debt

In an exclusive op-ed today for CNN, CRFB president Maya MacGuineas urges lawmakers not to give up on trying to use the debt limit increase as an opportunity to reach a "grand bargain," arguing that a small deal simply won't be enough. She writes, "[t]his is not supposed to be who we are: a country fighting over whether to pay our bills, being scolded by rating agencies -- including in China -- and on track to leave a shredded economy to the next generation because we spent years on a spending spree without paying the bills."


Click here to read the full commentary.


"My Views" are works published by members of the Committee for a Responsible Federal Budget, but they do not necessarily reflect the views of all members of the committee.

Fed Weighs Options on What to Do Next

Appearing before the House Financial Services Committee yesterday, Fed Chairman Ben Bernanke signaled that the Fed was keeping all options on the table should the economy need another round of monetary stimulus. Bernanke said that the "economy still needs a good deal of support" right now given the slow recovery in home prices and 9.2 percent unemployment--in addition, as he mentioned, to the threat that future deficits and debt pose to interest rates if left unaddressed.

At the same time, however, Bernanke noted the Fed would be prepared to move in the opposite direction if conditions warrant, exiting from the extraordinary measures employed so far to buttress the economy since the recession began if inflation picks up faster than expected. Internally, the Fed is far from unanimous about what to do next, with some members of the Federal Open Market Committee (FOMC)--the Fed's decision making body--calling for additional support if growth continues to slip while others, including Dallas Federal Reserve President Richard Fisher, are worried about a rising risk of inflation. 

CRFB has continued to track the Fed's actions on Stimulus.org, where we catalog how the Fed has increased the size of its balance sheet from about $850 billion before the recession to roughly $2.9 trillion right now. In the wake of the panic of the financial crisis in the fall of 2008, the Fed created a number of new lending facilities--such as the Term Auction Facility and the Money Market Mutual Fund Liquidity Facility--to provide liquidity in the face of frozen financial markets.  


Many of these facilities have already expired, but there are a few other actions that the Fed has taken that are ongoing. Right after the government placed Fannie Mae and Freddie Mac under conservatorship the Fed began buying mortgage-backed securities and Fannie and Freddie debt. These purchases rose gradually to a peak of about $1.3 trillion in May 2010, then declined to about $1 trillion. However, since August of last year, the decline in these purchases--that is, the amount of debt and MBSs that have matured--have been reinvested in Treasury securities to keep the size of the balance sheet from shrinking. That move, combined with the $600 billion of additional Treasury purchases that took place between November and June, constitutes QE2.

QE3 would likely look similar to QE2. As of right now, the Fed is still reinvesting maturing MBSs into Treasuries, so its balance sheet is holding steady. Which direction it heads next--and by how much--will be up to Chairman Bernanke and the rest of the FOMC. Certainly, a few more weak jobs reports and moderating inflation expectations could raise the likelihood of another round of quantitative easing.  

Moody's Considers Downgrading U.S. Over Debt Limit Stalemate

Update 7/15: S&P has joined Moody's in issuing new warnings to the United States. Putting the country on "negative watch," S&P warned that it could downgrade U.S. debt before the August 2nd deadline.

Today, Moody's announced that they are currently reviewing the United States' credit rating given the current stalemate in negotiations over raising the debt limit. The small but growing likelihood of lawmakers failing to increae the debt limit on time has prompted them to prepare for potentially downgrading the United States. In a statement today, Moody's said:

The review of the U.S. government's bond rating is prompted by the possibility that the debt limit will not be raised in time to prevent a missed payment of interest or principal on outstanding bonds and notes. As such, there is a small but rising risk of a short-lived default. An actual default, regardless of duration, would fundamentally alter Moody's assessment of the timeliness of future payments, and a Aaa rating would likely no longer be appropriate. 

With the August 2nd deadline approaching, policymakers must raise the debt limit as soon as possible to reassure creditors and credit rating agencies that we will not default on our debt. At the same time, policymakers should use this moment to begin addressing our fiscal challenges.


Debt Deal Talks Heading into the 11th Hour

The budget and debt-limit negotiations are approaching the 11th hour. Congressional leaders and the President continue negotiating over a deficit-reduction package, the size of which is still up in the air. Estimates have ranged from a “small package” of somewhere between $1 and $2 trillion to a larger deal of about $4 trillion, both over ten years. Some details of the discussions can be surmised from a presentation that House Majority Leader Eric Cantor (R-VA) gave to his caucus on 7/12.

But it seems that each day brings a flurry of new developments and proposals over how to raise the debt ceiling. For a while, there was talk that a “mini-deal” would consist of what was left of the low hanging fruit: a switch to the chained CPI and more discretionary cuts, most likely with a large portion coming from non-defense spending and other changes to some mandatory programs -- such as spectrum incentive auctions and changes to federal retiree benefits.

Last week, Speaker Boehner (R-OH) and President Obama had discussed the possibility of a "grand bargain" that would save roughly $4 trillion over ten years that would touch entitlements as well as tax reform. Over this past weekend, Speaker Boehner then said that the "grand bargain" was dead. In Monday's press conference, President Obama voiced his willingness to take “significant heat” from his party in order to reach a $4 trillion deal. Reports indicate that entitlement reforms, such as raising the Medicare entitlement age (see here for our analysis of this issue), means testing Medicare and Social Security and moving to the chained-CPI  have been floated in negotiations, but it's hard to know at this point what is still on the table. There is also a long list of health care cuts offered by Rep. Cantor such as Medigap reform, reform rural hospital programs and reducing bay debts.

Yesterday, Senate Minority leaders Mitch McConnell (R-KY) floated a proposal that would give the President more or less the authority to raise the debt limit three times (which have sparked sharp rebuke from many conservatives) this year through the use of three short term increases. The Congress would be allowed to prevent an increase with a two-thirds majority vote, which is highly unlikely. 

Chairmen of the Senate Budget Committee Conrad (D-ND) also released a blueprint yesterday for a Senate budget resolution (read more about that on our blog here), although the full details are not yet known but are expected to be released soon.

Time is running short and it's not necessarily clear that we're getting closer to a deal. But a deal must happen and it should include both an increase in the debt limit and meaningful deficit reduction. It is absolutely imperative that lawmakers raise the debt ceiling  as soon as possible. But they also need to enact the beginnings of a comprehensive fiscal plan (or perhaps even a full plan). Failing to do either could seriously jeopardize the financial strength of the U.S. in the future. 

Bipartisan Support for the Chained CPI

Talk of switching to the chained CPI for all inflation indexed elements of the federal budget has continued gaining much attention in the past few months, and the policy has been included in the ongoing debt ceiling negotiations (we'd like to think our policy paper had something to do with it). Predictably, it has come under attack from both the right and the left for raising taxes and affecting Social Security benefits, respectively. But people from across the political spectrum have also come to its defense.

On the right, Charles Blahous, a Social Security trustee, has defended the chained CPI as a justified technical change to keep with the government's goal of using a correct measure of inflation to adjust programs and provisions of the tax code.

Some federal policies (like the fixed income thresholds for the recently-enacted 0.9% Medicare surtax) aren’t indexed at all. Others (like Social Security’s benefit formula) are indexed to wage growth. But currently expressed policy in many other areas of the federal budget is to index for general price inflation, no more and no less. To use the best available measure of such inflation is therefore not a “benefit cut” or a “tax increase” as much as it is the most faithful available method of complying with the policy basis of various statutes.

On the left, Chuck Marr of the Center on Budget and Policy Priorities echoed our clarification of the distributional analysis of the tax impact of the chained CPI, in response to a Joint Committee on Taxation estimate. We argued that the JCT estimate both excluded the effects of AMT patches from the analysis and did not account for low-income people who do not file tax returns. Also, they used percent change in taxes paid, rather than the more commonly used percent change in after-tax income to measure the distribution. Here is Marr's take: 

The Tax Policy Center, which does not face the same current-law requirement, has conducted a parallel analysis that gives a more realistic assessment of how switching to the chained CPI would affect different income groups.  The results show that the percentage reduction in after-tax income — the best way of measuring the progressivity or regressivity of a tax policy change — is modest and nearly identical in all income brackets.

Many other individuals and groups have supported/defended the chained CPI: Donald Marron, the Washington Post editorial board, Reihan Salam, the Progressive Policy Institute, the Heritage Foundation, and Jared Bernstein. Also, the Center for American Progress included it in their Peterson Foundation fiscal plan.

As our policy paper on the chained CPI said:

Addressing our fiscal challenges will require many tough choices and policy changes - but switching to the chained CPI represents neither. Such a change offers policymakers the rare opportunity to achieve significant savings spread across the entire budget by making a technical improvement to existing policies. As such, across-the-board adoption of the chained CPI should be at the top of the list for any deficit reduction plan or down payment.

Spotlight on the States: Minnesota

Update 7/14: Gov. Dayton and the legislature have reached an agreement to fund the government through the biennium.

The federal government narrowly avoided a shutdown in April, but one state has not been so lucky in its fight over the budget: Minnesota. New governor Mark Dayton (DFL--Democratic-Farmer-Labor) and the Republican-controlled legislature have been sparring over the correct way to close its estimated $5 billion shortfall for 2012-2013 (13 percent of projected spending over that period). Although we have already looked at Minnesota in talking about the attention they paid to tax expenditures, this blog will go through the broader budget showdown that has caught the nation's attention.

The back-and-forth started in February, when the legislature passed a bill that would cut $900 million of spending, mostly from local aid and public colleges. The bill got no DFL support in either house and Gov. Dayton vetoed it. He countered with his own budget proposal, which would balance the budget over the biennium. The proposal included $2 billion in spending cuts and $4 billion in tax increases, including a three percentage point income tax rate increase for people making over $150,000 and a three percent surcharge on top of that for people making over $500,000.

However, the Republican-controlled legislature rejected the tax increases. So, the state House and Senate spent the next few months working to pass the appropriations bills necessary to fund the government with an overall goal of limiting spending to expected tax revenue. As they were working, a number of policies from these bills became lightning rods of criticism for DFL legislators and Gov. Dayton: rolling back Medicaid coverage for childless adults, broad education cuts, a 15 percent reduction in the government workforce, and the aforementioned local government aid cuts. Given the polarized discussion that took place over these bills and united DFL opposition to them, it became clear that the two sides were far apart.

On May 16, Gov. Dayton offered to scale back his tax increase to $1.8 billion, matching the size of his spending cuts. The additional $1.4 billion of (presumably) spending cuts needed to close the budget gap would be negotiated. This offer was also rejected by Republicans, who reiterated their call for no tax increases. The need for compromise was underscored just a week after the offer when Gov. Dayton vetoed all eight budget bills and the tax bill that the legislature had passed. The sides came no closer to passing a budget throughout the next month, so the government had to shut down at the start of the fiscal year a few weeks ago.

New updates on the impasse have come in the past week. Last Wednesday, Gov. Dayton made himself open to other forms of taxation to raise revenue, such as "sin" taxes, instead of his preferred income taxes on high earners. Last Thursday, a bipartisan group led by former Vice President Walter Mondale and former Minnesota governor Arne Carlson released a proposal that contained $1.4 billion of tax increases and $3.6 billion of spending cuts.

Still, these proposals have gone nowhere. Republicans remain unwilling to consider revenue increases, whether on cigarettes or on higher-income earners, and DFL'ers will not accept the spending levels passed by the legislature. The roughly $2 billion difference between the two sides is making all the difference in the world for the citizens of Minnesota.

If you think Minnesota's story sounds like the tale of budgeting in Washington over the past six months, you wouldn't be far off. Hopefully, lawmakers in Minnesota, as well as those here in Washington, can agree on bipartisan plans to control future deficits in the very near future and, in Minnesota's case, actually keep the government running.

Business Leaders Urge Policymakers to Raise the Debt Ceiling and Enact Long-Term Fiscal Plan

Yesterday, nearly five hundred business leaders and organizations sent a letter to the President and members of Congress joining the chorus of other concerned groups and citizens (including CRFB! Read more here) urging policymakers to raise the debt limit and also "agree to a plan to substantially reduce our long-term budget deficits with a goal of at least stabilizing our nation's debt as a percentage of GDP". Some notable signatories include: Vikram Pandit CEO of Citigroup Inc., John Chamber CEO and Chairman of Cisco, and Robert McDonald CEO of Proctor & Gamble Co. 

The United State's economic future is inextricably linked to the nation's budget.  A predictable long-term deal will likely provide business leaders with a renewed sense of confidence and certainty regarding future tax and spending levels, which could help create additional investment and job growth. It is essential for policymakers to put aside partisan differences and act in the nation's best interest by avoiding default and agreeing to a comprehensive long-term deal that will set the United States on a sound fiscal footing.

As the letter says:

"First, it is critical that the US government not default in any way on its fiscal obligations. A great nation - like a great company - has to be relied upon to pay its debts when they become due...

Second, our political leaders must agree to a plan to substantially reduce our long-term budget deficits with a goal of at least stabilizing our nation's debt as a percentage of GDP - which will entail difficult choices. The resulting plan must be long-term, predictable and binding. As businesses make plans to invest and hire, we need confidence that, in the absence of a crisis, our government will not reverse course and return to large deficit spending."


Details Emerging About Sen. Conrad's Budget

It's the budget that's been stuck in limbo. Sen. Kent Conrad (D-ND), chairman of the Senate Budget Committee, has reportedly been working on a Senate Democratic budget for months, seemingly having held off to see what happens first with the Gang of Six and now with the debt ceiling negotiations. While there has been no official release yet, we do have some broad outlines of what the budget looks like from a speech Sen. Conrad gave yesterday on the floor of the Senate.

The overall budget looks to save $4 trillion over ten years, roughly comparable to the House budget, but with half of the savings coming from increased revenue. The deficit would be put on a downward trajectory, reduced to 2.5 percent of GDP in 2015 and 1.3 percent of GDP in 2021. Although Sen. Conrad only gives a gross debt path for the plan, based on his deficit numbers we roughly estimate that public debt would be 68-70 percent of GDP in 2021, compared to 91 percent of GDP under the CRFB Realistic Baseline. Here are the major components of the savings:

  • Revenue Increases: The Conrad budget slightly alters the formula of the "Obama plan" for the tax cuts by extending them for people making less than $500,000/$1 million. The estate tax is set at 2009 parameters and the AMT is patched. In addition, the budget assumes $2 trillion in new revenue above that from cutting tax expenditures. The exact policies are not specified, but it seems that the plan's logic is that cutting tax expenditures should raise $2 trillion and any rate cuts on top should be paid for with further tax expenditure cuts. Also, though the plan doesn't increase revenue, there is corporate tax reform which cuts the rate to 29 percent and eliminates unspecified tax expenditures.
  • Defense Savings: Again, the specific changes that the budget makes are not yet known, but the Conrad budget aims to be more aggressive than either the President's Budget Framework or the House Budget in this area. This budget saves $886 billion in total security spending, equal to the savings from the Fiscal Commission plan. Whether these savings are accomplished through caps--like the Fiscal Commission--or with specific policy changes (for example the Sustainable Defense Task Force) remains to be seen.
  • Other Domestic Savings: These are a number of small measures such as freezing Congressional pay, freezing White House and Congressional budgets, reducing printing and travel costs, and reducing the number of contractors. Considering the topline savings and the size of the other areas of savings, this is not likely to be a big area of cuts.

Social Security is not touched in this budget, consistent with many of the other budgets that have been released this year. In addition, however, health care also appears to be left untouched (or at least there hasn't been any information about health-care changes). We will have to wait for the release of the final budget to be sure; for now, it sounds as if Sen. Conrad's plan is taking the "wait and see on health care reform" approach.

While we are eagerly awaiting the full details and numbers of Sen. Conrad's budget, we also hope that the White House and Congressional leaders can agree to a debt ceiling increase and the beginnings of a comprehensive plan as soon as possible.

‘Line’ Items: Goals Edition

Clutch Goals -- The U.S. Women’s Soccer team scored an improbable victory over Brazil on Sunday in the Women’s World Cup, overcoming a scoring and manpower deficit with a last-minute goal and sealing the victory through penalty kicks. A similar storyline is playing out in Washington involving a different deficit -- the federal budget deficit. It looks as if negotiations to raise the statutory debt limit and reduce the deficit will also come down to the wire. Hopefully, a last-minute deal can be achieved that averts the catastrophe of default, but it is difficult to score when the goals cannot be agreed upon. The cause was dealt a setback over the weekend as House Speaker John Boehner (R-OH) said a grand bargain including $4 trillion in deficit reduction would not be possible because his caucus could not support the tax increases involved. Negotiators, as they meet again today, must still decide how long of a debt-limit extension and how much deficit reduction they can agree upon in a quickly-diminishing timeframe. The Treasury Department says it cannot hold off a default past August 2, and the White House wants a deal soon to provide enough time to draft and enact the legislation codifying the agreement. CRFB recently offered its thoughts on what needs to come out of the talks and reiterated its position that a multi-year plan to stabilize the debt should accompany a debt ceiling increase last week in a statement. Let’s hope Team USA can pull out another dramatic win.

AMT…CPI…TBD – There is growing talk that a debt limit/deficit reduction deal will include a fix of the Alternative Minimum Tax (AMT) and a change to the Consumer Price Index (CPI). An AMT fix that keeps the tax from affecting the middle class while being offset by revenue increases elsewhere, such as through eliminating or reducing certain tax expenditures, could gain enough support on both sides to pass. And switching to an alternative CPI, which measures inflation and is used to adjust federal benefits like Social Security for cost of living changes year to year as well as certain tax breaks, could also find bipartisan support and produce significant deficit savings. A recent paper makes the case for how a switch to ‘chained CPI’ can reduce the deficit.

Ethanol Deal Fuels Tax Expenditure Reform Hopes – A bipartisan trio of senators announced late last week that they reached agreement on a measure to end tax subsidies for ethanol production. The deal reached by Sens. Amy Klobuchar (D-MN), John Thune (R-SD), and Dianne Feinstein (D-CA) will abolish the ethanol tax credit and dedicate two-thirds of the estimated $1.3 billion in savings to deficit reduction, with the rest going to promote alternative fuel development. The agreement underscores the increased scrutiny tax expenditures are receiving as lawmakers look for ways to reduce the deficit. See here and here for more on reforming tax expenditures.

Defense Spending Getting Harder to Defend – The House passed the FY 2012 Defense spending bill last week. Although it passed easily and is the only 2012 appropriations bill to increase rather than decrease spending over the previous year, votes on amendments presage Pentagon spending battles to come. For example, an amendment that would have shifted $200 billion in funds from reconstruction in Afghanistan to deficit reduction was narrowly defeated in a 210-217 vote.

Balanced Budget Amendment Gets Its Moment – House Majority Leader Eric Cantor (R-VA) announced that the House will vote on a balanced budget amendment to the Constitution next week. Senate Minority Leader Mitch McConnell (R-KY) also wants a vote in his chamber that week. The proposal preferred by Republicans will not only require that the President submit a balanced budget annually, but would also cap spending at 18 percent of GDP and require a two-thirds supermajority vote in Congress to raise taxes. The Peterson-Pew Commission on Budget Reform has offered its own blueprint for improving the budget process towards facilitating debt reduction in Getting Back in the Black. The Commission also recently produced a Fiscal Toolbox that summarizes and compares ideas like balanced budget amendments, spending caps, and debt triggers. Both publications are part of a one-stop online resource created by the Commission to help policymakers, media, and the public better understand the fiscal tools that are being discussed regularly.

Eyeing IPAB – The Independent Payment Advisory Board (IPAB), an entity created by the health care reform law to help constrain the rise of Medicare costs, will come under intense scrutiny this week with two congressional hearings. Both the House Energy and Commerce Committee and House Budget Committee will look at the agency. Lawmakers on both sides have raised concerns about the board because they claim it usurps congressional power. CRFB sees IPAB as essential to controlling health care costs and offered suggestions to strengthen it in a paper last year.

Ideas for Social Security Reform – The House Ways and Means Committee held a hearing on Friday on Social Security’s finances. CRFB board member Gene Steuerle was one of the witnesses and offered ideas to reform the program to ensure its long-term solvency. Among his recommendations were to increase the retirement age and capping expected lifetime benefits. See here for ideas from CRFB for strengthening the program’s long-term finances.

Key Upcoming Dates

July 11

  • Meeting between White House and congressional leaders towards a deal to raise the debt limit and reduce the deficit. President Obama is scheduled to give a press conference at 11 am ahead of the meeting.

July 12

  • House Budget Committee hearing on “Medicare’s Future: An Examination of the Independent Payment Advisory Board” at 10 am.

July 13

  • House Energy and Commerce Committee hearing on “IPAB: The Controversial Consequences for Medicare and Seniors” at 9 am.
  • House Budget Committee hearing on “Medicare and Social Security: The Fiscal Facts” at 10 am.
  • Federal Reserve Chairman Ben Bernanke testifies before the House Financial Services Committee at 10 am.

July 14

  • Senate Finance Committee hearing on “Perspectives on Medicaid from Select Governors” at 2 pm.

August 2

  • Treasury Secretary Geithner says that the U.S. will default on its obligations by around August 2 if the statutory debt ceiling is not increased before then.

CNN MONEY EXCLUSIVE: Go Big on the Debt Ceiling

In her latest commentary for CNN Money, CRFB president Maya MacGuineas urges Washington lawmakers to go big on the debt ceiling. She also lays out what we should be looking for in a debt-ceiling deal, and says that "the bottom line is that any real deal needs to be large, specific and passed this year to be seen as credible. Out of this debt ceiling negotiation, we should expect no less."


Click here to read the full commentary.


"My Views" are works published by members of the Committee for a Responsible Federal Budget, but they do not necessarily reflect the views of all members of the committee.