The Next Deficit-Reduction Deal

So, assuming this debt-ceiling deal gets done, are we out of the woods? Not by a long shot. Let’s revisit what Standard & Poor’s said on July 14:

Since we revised the outlook on our ‘AAA’ long-term rating to negative from stable on April 18, 2011, the political debate about the U.S.’ fiscal stance and the related issue of the U.S. government debt ceiling has, in our view, only become more entangled. Despite months of negotiations, the two sides remain at odds on fundamental fiscal policy issues. Consequently, we believe there is an increasing risk of a substantial policy stalemate enduring beyond any near-term agreement to raise the debt ceiling.

As a consequence, we now believe that we could lower our ratings on the U.S. within three months.

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.

How good a deal do we have before us? Does it rise to the level of credible solution to the rising U.S. government debt burden?

Let’s assume perfect execution, meaning $2.5 trillion in deficit-reduction over the next decade. Under current Congressional Budget Office projections, debt held by the public will amount to about $10.35 trillion in 2011 (69 percent of our $15 trillion GDP) and will grow to $20.1 trillion in 2021 (101 percent of an expected $19.9 trillion GDP). That’s under the CBO’s less-rosy “alternative fiscal scenario,” meaning that the Bush tax cuts are not allowed to expire, that the deep Medicare spending cuts that consistently have been put off continue to be put off, etc. (Couple of notes: 1. These figures are in constant 2011 dollars. 2. Debt held by the public, rather than total debt, including such intragovernmental debt as the money owed to the fictitious Social Security trust fund, is not my favorite measure of debt, but I’ll stick with it here, since the CBO is using it. 3. Have a look at the CBO numbers here.)

So, one way of looking at this is that we’ll shave off the equivalent of about 26 percent of the additional public debt we are expected to accumulate in the next decade. That’s not nothing.

Another way of looking at this is that, even with this deal in place, the public debt will grow by about 70 percent in the next decade in dollar terms, and about 47 percent in terms of GDP share.

Which means: Even if this deal is done, and even if it is perfectly executed, we continue to press toward national insolvency. At the very least, that means we can probably kiss that AAA credit rating goodbye, and soon. If losing the AAA drives up the cost of borrowing, that will make the deficits that much worse, which will put additional pressure on our credit rating.

Conclusion: Republicans should begin work on the next deficit-reduction plan as soon as the president signs this one (if he signs it). It will need to address entitlement reform, since entitlement spending will be the major driver of deficits going forward; there really is not much of a choice.

The debt-ceiling debate is only coincidentally related to the underlying issue of deficit reduction: The statutory debt ceiling provided a political opportunity to force a deal. But it is not the only such opportunity, and Republicans should continue to make the most of every choke point in the legislative process to press for additional spending cuts. They are making gains, but the gains are insufficient.


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