Down on the Downgrade?
John Berlau, Chris Chocola, Burton Folsom, and others talk about the S&P.


Veronique de Rugy
We can debate whether or not Standard & Poor’s should have downgraded the credit rating of the United States, but one thing is sure: The rating agency’s decision seems consistent with its July 14 warning on the matter. At the time, S&P laid out clear criteria for avoiding a downgrade: Agree to a credible plan to reduce the debt-to-GDP ratio within three months and guarantee this new-found fiscal discipline will actually stick.

What does it mean? Anyone who has looked at a Congressional Budget Office or Office of Management and Budget baseline understands that the debt problem in the United States will not go away as long as we don’t reform the major sources of the spending explosion — Social Security, Medicare, and Medicaid — which will blow apart any possibility of an equilibrium between revenue (no matter how high marginal rates get) and expenditures.

Unfortunately, the debt-limit deal failed to even fake a solution. The debt ceiling was raised. We got downgraded.

Who’s to blame? While S&P take notes of the Republicans’ unwillingness to raise revenue, it also explains that “the plan envisions only minor policy changes on Medicare and little change in other entitlements, the containment of which we and most other independent observers regard as key to long-term fiscal sustainability.” Basically, it would have been key to show signs of willingness to cut these autopilot programs. That didn’t happen, since many lawmakers in Congress (Democrats mainly, though not exclusively) refuse to talk about reductions in entitlement spending. It makes it hard to argue that Republicans are the only ones to blame for the downgrade.

Now, by maintaining a negative outlook on the U.S. credit rating, S&P is warning us that further downgrades are likely if lawmakers fail to adopt real reforms to reduce the debt-to-GDP ratio. Thankfully, we are not the first nation to struggle with a dangerous debt-to-GDP ratio, and we can learn from others’ mistakes and successes.

Recently, Harvard’s Alberto Alesina and Silvia Ardagna looked at 107 efforts to reduce debt in 21 OECD nations between 1970 and 2007. Their results suggest that spending cuts are a more effective way than tax hikes to reduce debt-to-GDP ratios. American Enterprise Institute economists Andrew Biggs, Kevin Hassett, and Matthew Jensen find similar results: The unsuccessful fiscal consolidations they studied consisted of 53 percent tax increases and 47 percent spending cuts, while successful fiscal consolidation consisted of 85 percent spending cuts.

In other words, historically, the more “balanced” approach (a mix of revenue increases and spending cuts) widely advocated these days in Washington leads to failure to reduce the debt-to-GDP ratio. The United States cannot afford to follow this pattern.

— Veronique de Rugy is a senior research fellow at the Mercatus Center at George Mason University.