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Moody's warns of consequences of continued deficits

Historic Wall Street marker
Historic Wall Street marker
AP Photo/Mark Lennihan

Moody's Investors Service, Inc. indicated today that the U.S. government bond rating of Aaa could come under pressure unless immediate action is taken by the government to stall the course of deficit spending and begin to reduce the overall deficit level. Moody's cautioned that the level of current debt in relationship to GDP has risen dramatically over the past year to eighteen months and as a result, the ratio of government debt to GDP in the U.S. economy is higher than other countries with a Aaa rating.


The importance of the quality credit rating for the U.S. relates to the ability to borrow from a myriad of foreign and domestic sources at rates far more favorable than countries issuing debt with a lower credit rating. Maintenance of the Aaa rating is fundamentally tied to the economic and institutional strength and outlook within the U.S. economy and the U.S. government. This year, in order to finance the present level of deficit spending projected, the U.S. government will sell $2.43 trillion in debt obligations; a 16% increase over the record $2.1 trillion sold in 2009.

As I assess this news story today, I am drawn back to my firm's monthly Economic Updates where over the past year, we have continually warned of the economic malaise that is created by growing deficits and deficit spending (http://apexhealthcareconsultants.info). Moody's essentially confirmed what we have been saying for the past year.
 

  • The level of spending at its current rate is unsustainable over the intermediate term, even with a moderately growing economy.
  • The current level of debt is inflationary and as a result, will lead to the U.S. government having to raise interest rates in order to attract buyers for its debt. Once begun, this cycle will raise the cost of debt via interest expense to the U.S. government thereby consuming a greater percentage of the total budget, leaving less resources available for other programs and spending.
  • If the Government's cost of debt increases and its resulting debt levels remain on the increase, economic recovery may stall rather quickly and the economy return to recession.

From a political perspective, Moody's statement today is a clear blow to the Obama budget and the Democratic majority in the House and the Senate. Our analysis of the overall Obama plan plus the current state of the U.S. government's present and future debt points directly at the problems Mr. Obama and his party face today and will face through the federal budget cycle.
 

  • At the current pace of spending and projected GDP growth, regardless of a new budget, the debt level of the government will match and exceed the total GDP by the end of 2010. In 2011, unless GDP grows substantially faster than most economists believe will occur, the debt level will surpass the level of GDP.
  • Entitlements present the largest problem for deficit reduction but also the greatest opportunity to achieve substantial savings. Medicare alone weighs in at $500 plus billion today and by the end of the decade, is projected to reach the $1 trillion level under current program assumptions. By 2017, using current economic assumptions, Medicare becomes financially insolvent. By 2014, the General Revenue share required by Medicare to remain solvent moves to 47%. Simply put, by the middle of this decade, almost as many general purpose revenue dollars will be diverted from all other government spending programs to Medicare, just to keep the program solvent - $345 billion.
  • Medicaid is an additional source of problems today, principally driven by the economic woes in the States, the unemployment levels, and the burden imposed on the Federal government to increase funding levels (match and outright support) to the States to keep Medicaid solvent. Even with the increased federal funds allocated via the ARRA, the States are seeking continuation of the support levels and ideally, increases.
  • Politically popular programs such as SCHIP have been expanded in recent years to cover more citizens at higher income levels, establishing a new population of government entitled individuals. Reigning in this growing level of spending just recently expanded will no doubt be politically difficult.
  • Mr. Obama's political agenda has been heavily based on expanding government based entitlement programs and the creation of new levels and programs of entitlement, especially in the areas of education and health care. Both of these areas present significant opportunities for spending reductions and therefore, deficit reduction.

My final comment is that budget deficit reduction will not fundamentally occur in Washington until three major issues are addressed.

The first is entitlement reform, principally in Medicare, Medicaid, and Social Security.

Second, discretionary spending reductions combined with the elimination or substantial reduction in pork spending in education, energy, commerce, health and human services, transportation and agriculture. Each of these departments or spending areas is over-loaded with duplicative programs, pork and discretionary project spending. Simply stated, I believe as do most policy analysts and economists, that a $250 billion reduction in spending could be achieved with modest entitlement reform and discretionary spending discipline in one year with additional savings in the second year moving into the $400 billion range.

The third and final area to address is income tax reform, principally a simplification and flattening process to assure that the revenue base is as wide as possible and that nearly all income earners are paying for government services. This approach raises overall revenues while improving the incentive for continued small business investment and entrepreneurial investment. Presently, nearly fifty percent of all citizens pay no income tax or virtually no income tax.
 

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