Tough decisions ahead to get AAA rating back

Credit rating agency opinions always provide the steps a company or government needs to take in order to improve its grade. Standard & Poor’s rating action on the U.S., which downgraded the country’s long-term debt from AAA to AA+, includes the information that the U.S. needs to consider to recover its AAA rating.

24/7 Wall St. analyzed this report and found that the recommendations of S&P fall into a few categories. First among these is that national debt as a percentage of GDP must decrease from its current level of 74 percent. The rating agency will need to be convinced that this will continue over the next decade. S&P also says the budget savings and increases in government receipts must be greater than those that came out of the compromise the two political parties just agreed to prevent a default. Directly related to that, the Congressional Joint Select Committee on Deficit Reduction, which is charged by November of this year to cut another $1.5 trillion, spread out over the next decade, would have to make major cuts in the largest entitlement programs.

In the future, S&P indicates, Congress and the Administration will have to choose expense reductions in the largest entitlement programs, which would be in the hundreds of billions of dollars spread out over the next 10 years. S&P has already rebuked the political system that prevented the Administration from increasing taxes to begin to balance the budget. This rating agency made it clear that budget cuts alone are not sufficient but that taxes must be increased in order for the U.S. to regain its former credit rating. The most critical issue raised by the rating agency is that the federal government would need to create a framework to address the costs of an aging American population.

S&P did not factor in to its decision the possibility that the U.S. economy could make a sustained and robust recovery. If that happened, the nation’s budget problems would not disappear, but could improve enough so that the severe strain of entitlement costs might be delayed by a few years.

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S&P’s concerns can be divided into two categories that subsume almost all others. The first is that Americans are growing old and the consequent increases in entitlement costs cannot be sustained alone by the current tax collections for programs like Social Security. The young cannot take care of the old anymore, at least based on the level at which those under 40 are taxed for entitlements. Debt as a portion of GDP will worsen, in part, because there is no vision for a new way to provide some level of basic support for the elderly. This vision could require an increase in the age at which Social Security and Medicare benefits could be accessed and the exclusion of people who have savings or jobs from both of these programs.

It may take a financial catastrophe — a day when America actually cannot raise money in the global capital markets — for voters to acquiesce to real austerity and higher taxes. The most radical analysts of America’s financial future believe that the U.S. will have to look like Greece does today before voters act to salvage the nation’s financial future.

There is a single argument that voters may use to dodge responsibility for America’s credit status. U.S. GDP could begin to surge as it did in the 1996 to 2000 period, when the average annual improvement was over 4 percent. That seems improbable because recent U.S. GDP growth has been less than 2 percent. Some economists still believe that overseas demand for American goods and services, along with an improvement in employment prospects in the U.S., will drive U.S. growth much higher again. That means the ability of GDP to rebound is based on both global economic factors as well as American policy. More rapid growth in the U.S. economy might put off the day when the government will face severe debt problems, but debt is still 74 percent of GDP, and even with strong growth, government expenses will keep that number high. In other words, voters still will have to decide what will become of entitlement and taxes, even if 2 percent GDP growth accelerates.

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S&P probably will do nothing to the country’s new AA+ rating soon, although its analysis warns that there could be another downward revision in the next 12 to 18 months. The agency likely will wait to see the results of the 2012 election. Based on who is sent to Washington and who is sent home. Voters will make the only significant determination about whether the U.S. gets its AAA rating back.

The S&P has created a reasonable road map for the U.S. to get its AAA rating back that conforms with the opinions of the majority of economists. There are a limited number of actions that the U.S. can take, and each will involve some level of sacrifice.

The other crucial area of concern from the S&P revision is that budget cuts alone are not enough to make sharp deficit reductions. Additional revenue to the Treasury will be needed, which means taxes will have to increase.

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Politicians, the media, and economists have all offered detailed solutions for deficit reduction and improving America’s financial fortunes. Most of these can be matched to S&P’s criticisms:

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1. Government benefits: Americans have to decide that they will not get as much government support as they age. This seems overly simplified, but it is the people who will receive the money who have to decide to give it up. People in their 50s and 60s make up a powerful voter block. The people in this large demographic pool can almost certainly use their ballot power to block the election of politicians who support cuts in entitlements. The Baby Boomers and their younger demographic cohorts would have to decide there is some value in self-sacrifice. Under new programs, benefits might not begin until people are 70. People with assets above a certain level might get no Social Security at all. Whatever the formula, Americans who reach what was formerly known as retirement age sometime in the next 10 years will have to decide to live with less support from the government. These voters will go to the ballot box in 2012. They will either insist on what they have come to regard as their earned retirement or they will agree to give up some of those benefits for what could very well be a greater good, in order to prevent our borrowing costs from increasing.

2. Raise taxes: The efforts of the Administration to raise taxes as part of the budget deal failed. Some economists think this was the worst part of the compromise. They argue that the federal government cannot cancel enough programs to create a balanced budget. Individuals and corporations will have to pay more in taxes. Ironically, the taxpayers must decide whether they will pay more taxes. The current Congress has already made its decision on the matter. It is up to Americans to choose politicians in the 2012 elections who favor moderate tax increases for individuals and U.S. companies. Taxes can be raised in thousands of ways. But, there must be a willingness to raise taxes in order to meet the demands of the S&P review.

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3. Defense budget: The Defense budget still supports large deployments of people and material overseas. This is not just in Afghanistan and Iraq. There are large concentrations of troops in Europe and Asia. America has commitments to NATO. Others exist because the federal government believes it needs to support strategic initiatives in places like Japan. Any real cut in the Pentagon budget means a decrease in these obligations.

4. Reduce social programs: The government currently supports a long list of “underprivileged” Americans that goes beyond classic entitlements. One of the most visible of these is the unemployed population. In order to preserve services to the traditional entitlement programs, it may be necessary to reduce or eliminate other social programs.

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5. Limit medical care: Aging is a significant burden on medical costs from Medicare. Other nations like Canada and England have turned to what is essentially a rationing of medical treatment. Costs have been lowered in these countries through systems that mandate longer waiting times for treatment and a decrease in treatment options.

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6. China: Taxes of U.S. companies and individuals need not be the only way for the government to raise revenue. There has been a groundswell in Congress to pressure China to alter the value of its currency to make trade between the two nations “fair.” Some economists believe cheap goods exported by China have caused a loss of manufacturing jobs in the U.S. The U.S. could place tariffs on more Chinese goods as a way to raise money and prevent “dumping” of products from the People’s Republic into the U.S.

7. Reduce Social Security: Older Americans could press Congress to curtail Social Security obligations to people who are 40 or less when they retire. That would make it easier for the government to handle entitlement costs in the future. It would also set up a battle about future deficits along age lines more than the party lines created by Democrats and Republicans. S&P wants gridlock to disappear from Washington now to prove the government has the will to improve the American financial situation. That won’t happen now. But it could in 2012, depending to a large extent on who wins the battle for entitlements.

There is one thing to gain from the S&P analysis. America’s situation is not hopeless unless Americans make it so.

Copyright © 2011 24/7 Wall St. Republished with permission.

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