America Downgraded

National Review Online

Thursday, August 03, 2023

 

Rating agency Fitch downgraded U.S. sovereign debt from AAA to AA+. That’s only the second time any of the big three rating agencies have downgraded U.S. debt. S&P did so in 2011.

 

Treasury secretary Janet Yellen said she “strongly disagrees” with the decision, and she’s free to do so. There is a certain amount of arbitrariness in rating agencies’ decision-making, and it’s not the end of the world. But policy-makers, including Yellen, should take seriously the federal government’s spending problems, which left unfixed will lead to much more severe consequences than this.

 

One of the most damaging bipartisan beliefs in Washington right now is that the debt is a second-order problem and entitlement spending is not in need of reform. Democrats and Republicans have both spent irresponsibly, in recent years under an assumption of low interest rates that no longer holds.

 

Why Fitch chose this particular moment to downgrade the debt is unclear, but most of the reasons it lists for its decision are sensible concerns. If anything, it might be a little too nice.

 

“The repeated debt-limit political standoffs and last-minute resolutions have eroded confidence in fiscal management.” What confidence? The federal government has run a deficit, whether the economy is booming or busting, in war or peace, every year since 2001. Even before that, Congress rarely passed spending bills on time in accordance with the law.

 

Government by continuing resolution, where Congress rubber-stamps previous years’ appropriations, has become the norm. And that’s for the parts of the budget that are supposed to be discretionary. The mandatory parts, which account for most of the budget in absolute terms and most of the projected growth in the budget in the future, aren’t debated at all.

 

Both parties have agreed to not reform the bulk of mandatory spending: entitlements. The rationalization for this agreement is political, not fiscal. There’s no escaping the math.

 

CBO projections show that as a percentage of GDP, discretionary spending is basically flat over the next 30 years. So is mandatory spending outside of Social Security and health-care programs. Social Security is set to increase, but not as much as Medicare, Medicaid, and interest payments. The parts of the budget that cause U.S. budgetary problems are the parts of the budget that politicians have refused to reform.

 

The other part of what makes the CBO projections so alarming is that they forecast a long-term decline in potential U.S. GDP growth. Slower growth makes all these problems harder, by reducing the amount that the government can sustainably spend without spurring negative consequences such as inflation, and by seeding discontent among voters who might then demand more spending.

 

“Over the next decade, higher interest rates and the rising debt stock will increase the interest service burden, while an aging population and rising healthcare costs will raise spending on the elderly absent fiscal policy reforms,” Fitch says. The bill that fiscal hawks have been warning about will come due in the near future if no changes are made.

 

The massive spending during the Covid pandemic is not on track to be offset by leaner budgets now. And it’s worth remembering that had Biden gotten his way during the Build Back Better Act debate, the debt would be trillions larger.

 

Fitch mentions tax cuts as well, but the federal government set a revenue record of $4.9 trillion — nearly 20 percent of GDP — in 2022 and still spent $1.4 trillion more than it took in. Revenue only averaged 16.5 percent of GDP between 2002 and 2021, so 2022 was a great haul for the Treasury, and it was still nowhere near enough. Spending is rising faster than revenue, which the CBO projects to remain stable as a share of GDP over the next 30 years, and politicians won’t be able to tax their way out of this mess.

 

Bond ratings aren’t gospel, and Fitch could change its rating back to AAA in the future. But policy-makers should beware the consequences of continuing to ignore the federal government’s pressing fiscal problems. Interest rates aren’t zero anymore, and the actuarial tables are what they are. The best time to sober up was yesterday; the second-best time is now.