Thursday, January 3, 2013

Moody's: Fiscal Cliff Deal a Mixed Bag

After the fiscal cliff deal passed, Moody's, which still gives the USA a AAA credit rating, warns that further deficit reduction will be needed:
Moody's Investors Service said that the fiscal package passed by both houses of Congress yesterday is a further step in clarifying the medium-term deficit and debt trajectory of the federal government. It does not, however, provide a basis for a meaningful improvement in the government's debt ratios over the medium term. The rating agency expects that further fiscal measures are likely to be taken in coming months that would result in lower future budget deficits, which are necessary if the negative outlook on the government's bond rating is to be returned to stable. On the other hand, lack of further deficit reduction measures could affect the rating negatively. Notably, yesterday's package does not address the federal government's statutory debt limit, which was reached on December 31. The need to raise the debt limit may affect the outcome of future budget negotiations.
Although the fiscal package raises some revenue through higher tax rates on individuals earning more than $400,000 ($450,000 for joint filers) and through some other smaller measures, the estimated amount of increased revenue over the next decade is far outweighed by the amount of revenue foregone through the extension of lower tax rates for those with incomes below $400,000, the indexation of the alternative minimum tax, and other measures. 
This portion of the ratings report seems to be generating the most headlines.

But there's another portion of the statement suggesting that this deal was a net economic positive:
The macroeconomic effects of the package are positive, since it averts the recession that would likely have occurred had personal income taxes gone up for all income levels. However, the increase in the Social Security payroll tax from 4.2% to 6.2% of income that became effective on January 1 will likely be a constraint on growth in coming quarters. Furthermore, expenditure cuts that may be decided in coming months could also affect the rate of GDP growth in the near term. Overall, therefore, the recent package mitigates part of the fiscal drag on the economy associated with the fiscal cliff but does not eliminate it. 
 That paragraph is one McConnell and Boehner might take some solace in, along with President Obama and his allies.

Perhaps the principal thing driving the debt over the short and medium term is the sluggish economy.  Keeping the economy from slipping into a deep recession is also a powerful deficit reduction tool.  Both Republicans and Democrats could keep that in mind.

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