Failure of the congressional joint committee on deficit reduction likely means little chance to make progress on comprehensive tax or entitlement reform before the November 2012 election.
Now that the economic anchor has dropped, Washington still has to make difficult choices that will likely be a drag on already slow – but recently improving – economic growth. However, given the resiliency in Washington and Congress’s constant focus on electability over sustainability, it would not be surprising if they found a way around the mandatory cuts. After all, the ratings agencies have said that a debt downgrade is not imminent, which could have the political effect of inspiring further inaction.
Failure of the
committee may present some economic hurdles, as it reduces the chances of
extending recent tax breaks like the payroll tax cuts that are set to expire at
the end of this year. Further, we will see mandatory cuts in entitlements and
defense to the tune of around $600 billion each. These enforcement mechanisms
do not take effect for 14 months, and how those cuts will be enacted is
currently a bit unclear. Some members of Congress are already talking about
reconfiguring the cuts. We should have
more clarity on where the cuts come from as we move closer to the time they are
enacted in 2013. These automatic cuts were supposed to be painful enough that
they could force agreement in Washington, but it now appears that our
representatives in Congress would prefer to throw out an anchor on economic
growth rather than tackle spending. Failure to reach a deal has the potential
to decrease GDP growth next year by nearly 1 percent, attributed primarily to
the ending of some tax breaks and not extending unemployment benefits. Failure also kindled fears about Washington’s
willingness to overcome political gridlock and take the necessary steps to
improve the nation’s fiscal health.
Despite
the failure, Standard & Poor’s reaffirmed that it would keep the U.S.
credit rating at AA+ after removing its top AAA grade on August 5. Moody’s
Investors Service reaffirmed its AAA rating with a negative outlook. In a
statement following the super committee’s announcement that it was unable to
reach a compromise, Fitch Ratings noted that it said in August that a super
committee 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. It is worth noting that bond investors have shrugged off
the August downgrade, as yields on 10-year U.S. treasuries stood at 2.56
percent on August 5th, the time of the S&P downgrade of U.S. debt, and are
now around 2 percent.
With an economy still trying to climb out of one
of the worst financial crises in history, I believe more political leadership
will be needed to right the economic ship.
