Supercommittee Failure Poses Threat to Economy

The failure of the supercommittee to reach any agreement on a debt reduction plan is likely to pose a threat to the already struggling US economy. The inability to reach an agreement also doubt about lawmakers abilities to overcome partisan gridlock.

By Heidi Przybyla
Nov 22, 2011 7:55 AM MT
Bloomberg

The implosion of the congressional supercommittee is likely to delay any major deficit-reduction agreement until after the next presidential election and may pose an immediate threat to the struggling U.S. economy.

The committee’s failure to reach a deal means several tax programs, including a payroll tax holiday, risk expiring at the beginning of next year, weighing on the household spending that accounts for about 70 percent of the world’s largest economy.

The panel’s inability to agree on $1.2 trillion in budget cuts, which drove stocks down yesterday and Treasuries higher, also stoked doubts about U.S. lawmakers’ ability to overcome partisan gridlock and safeguard the nation’s fiscal health.

“They could not agree even on the smaller challenge of $1.2 trillion,” said former White House budget director Alice Rivlin, among a coalition of officials who pushed the panel to “go big” and find $4 trillion in savings, in an e-mail. “I do not see a way to get to the big deal before the election, if then. It is really discouraging!”

Still, Standard & Poor’s reaffirmed that it would keep the U.S. credit rating at AA+ after stripping the government of its top AAA grade on Aug. 5. Moody’s Investors Service reaffirmed its AAA rating with a negative outlook. Fitch Ratings noted in a statement that it said in August that a supercommittee failure would probably result in a “negative rating action,” likely a revision of its outlook to negative, and that a review would be concluded by the end of this month.

Trigger in Jeopardy

S&P said its rating would stand because the committee’s failure triggers $1.2 trillion in automatic spending cuts, which were put in place in the event no compromise could be reached. Easing those automatic spending limits may cause “downward pressure on the ratings,” S&P said in a statement.

That so-called trigger may be in jeopardy, with both Democrats and Republicans leery of steep cutbacks at the Pentagon that Defense Secretary Leon Panetta has called “Draconian.” Congress has succeeded in the past in undoing debt-reduction enforcement mechanisms.

Republican Senators Lindsey Graham of South Carolina and John McCain of Arizona already are looking for other cuts to take the place of those the Pentagon faces. Representative Howard McKeon of California said he would introduce legislation to prevent the spending reductions to defense.

“They have to really be careful not to mess with that,” said Robert Bixby, head of the nonpartisan Concord Coalition, which presses for debt reduction. “To dismantle it would be totally unacceptable.”

‘Radical’ Suggestion

Appearing this morning on Bloomberg Television, Senator Dick Durbin of Illinois, the chamber’s No. 2 Democrat, picked up on a Twitter suggestion from Illinois’ other senator, Republican Mark Kirk, that a bipartisan group of senators known as the Gang of Six take the lead in restarting deficit negotiations.

“I would like to see the leadership in the Senate say something that’s kind of radical: Let’s take this to the Senate floor,” said Durbin, who was part of the Gang of Six. “Any proposal that meets the president’s guidelines in terms of deficit reduction that is proposed on a bipartisan basis will get a vote on Feb. 1 or sometime around that date, and we’ll just have the debate and substitute amendments, and have a vote.”

That would encourage senators to “come up with something that’s bipartisan, that works, that’s an alternative” to the automatic cuts, he said. “It’s a challenge which the Gang of Six would accept, and I’d like to see us put something forward.” He said there would be a conference call this afternoon to discuss the “bipartisan opportunity.”

Economic Risk

Investors have largely shrugged off S&P’s August downgrade of U.S. debt to AA+ from AAA. After the move by the ratings company, the government’s borrowing costs fell to record lows as Treasuries rallied.

The yield on the benchmark 10-year Treasury note fell from 2.56 percent on Aug. 5 to below 1.72 percent on Sept. 22. The yield on the 10-year note was 1.96 percent at 9:32 a.m. in New York today, according to Bloomberg Bond Trader prices. The Standard & Poor’s 500 Index (SPX) was at 1191.15, down 0.15 percent, at 9:35 a.m.

Trouble may lie ahead for the economy. The supercommittee was considering rolling into its final product expiring tax provisions that must now be addressed before January.

Representative Dave Camp of Michigan, chairman of the tax- writing House Ways and Means Committee, has expressed concern about the cost of extending the payroll tax cut. Other Republicans on that panel, including Representative Kevin Brady of Texas, have said that they would be opposed to an extension.

Bad Hand?

Bill Hoagland, a former Republican staff director of the Senate Budget Committee, said this position puts Republicans in a bind. During the debt negotiations, they objected to ending the tax cuts for upper-income earners enacted under President George W. Bush. If Congress fails to extend the payroll tax cut, which affects many more Americans, “that’s going to play into somebody’s hand,” Hoagland said, meaning Democrats.

An end to the reduction in payroll taxes would subtract 0.5 percent from gross domestic product in 2012, while failing to extend unemployment benefits would cause a separate 0.3 percent decline, according to JPMorgan Chase & Co. chief U.S. economist Michael Feroli.

At the same time, any extension of the tax holiday will add to the nation’s debt now that there’s no broader deficit- trimming agreement.

“It’s certainly going to look awkward to do a number of these things that expand the deficit over the next year,” said Bixby.

Impairing Economic Growth

Earlier this year, the Congressional Budget Office estimated that U.S. debt will reach 187 percent of gross domestic product by 2035. Even after the trigger takes effect, the debt will grow to between 134 percent and 164 percent of GDP in 2035, according to the New York-based Peter G. Peterson Foundation, which works to focus public attention on the U.S.’s fiscal deficit.

“History suggests that a debt-to-GDP ratio of more than 60-90 percent can impair economic growth and produce crises,” Peterson said in a statement.

After addressing these more immediate agenda items, congressional lawmakers are likely to turn to altering the trigger’s equal blend of domestic and defense cuts.

So far, Graham and McCain have proposed a 10 percent reduction in pay for members of Congress and a 5 percent cut elsewhere in the budget. The two members of the Senate Armed Services Committee haven’t spelled out other targets.

$1 Trillion Reductions

If Republican efforts to reverse the automatic defense cuts fail, the Defense Department’s budget would face reductions of about $1 trillion over a decade, the most of any department.

The Pentagon already is cutting about $450 billion from its budget over the next decade as a result of the Budget Control Act that President Barack Obama signed into law Aug. 2, the same measure that created the supercommittee. The panel’s failure to reach an agreement increases the defense cuts by about $500 billion, excluding interest savings, starting in January 2013.

On the domestic side, the CBO estimates that 71 percent of the cuts would come from programs such as education, the environment, transportation, housing assistance and veterans’ health care.

An administration official who briefed reporters said the president will oppose any effort to alter the automatic cuts and will veto any attempt to undo the legislation. The White House is still hoping the enforcement mechanism, which doesn’t take effect for 14 months, will force Congress into a deal, said the official, who spoke on condition of anonymity.

Medicare, Medicaid

The supercommittee’s failure to reach an agreement takes the Medicaid health-insurance program for the poor off the table for potential cuts. Cuts to Medicare, the federal insurance program for the elderly and disabled, are limited to a maximum of 2 percent for payments to hospitals, doctors and other health providers and to private health plans participating in the Medicare Advantage program.

The supercommittee was largely derailed by a standoff between Democrats and Republicans over the expiration of the tax cuts enacted under Bush.

Republicans wanted to extend them all, and Democrats pushed to allow the tax breaks for top earners to lapse. If Congress does nothing, the cuts will expire in January 2013, and taxpayers will face higher rates on wages, capital gains and dividends.

“Republicans did overreach by taking the position they had to extend all of the expiring tax provisions,” said Hoagland. “Democrats were just completely unwilling to make any kind of fundamental structural changes to Medicare.”

To contact the reporter on this story: Heidi Przybyla in Washington at hprzybyla@bloomberg.net

To contact the editor responsible for this story: Mark Silva at msilva34@bloomberg.net

To see original article CLICK HERE

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