Here’s a couple contrarian takes on S&P’s analysis of the effect of gridlock in Washington, the debt ceiling deal we just reached, and how it affects next year’s scheduled expiration of the Bush Tax Cuts. First, Dan Drezner at FP:
It’s totally fair for S&P to factor politics into their assessment of sovereign debt. Indeed, a key trend in sovereign debt analysis over the past five years has been the recognition that political fundamentals can matter as much as economics. That said, if ratings agencies are going to do this, then their political expectations can’t just be retrospective — they need to do some actual forecasting. Instead, they looked at recent weeks and extrapolated into the future.
There are three factors that should give S&P pause before assuming that political dysfunction could lead to no increae in tax revenue. First, as Drum points out, despite all the displays of ideological inflexibility, in the end the debt ceiling vote secured a strong majority of the GOP House caucus. Some Tea Party members were willing to risk a crisis, but not actually go and perpetuate one. It was not a Great Moment in Democracy, but in the end a deal was done. You can’t dock for intransigence without noting the outcome.
Second, unlike the debt ceiling, deadlock in late 2012 means that the Bush tax cuts expire. Either a lame-duck Obama or a newly-re-elected Obama will be able to make that fiscal decision (no way any faction in Congress musters the 2/3 vote necessary to override). As Jonathan Chait has repeatedly observed, that dynamic is the opposite of the debt ceiling episode, in which case paralysis led to bad fiscal outcomes. If S&P thinks partisan gridlock will persist on Capitol Hill, then the conclusion to draw is that taxes will go up.
Third — and this is pretty important — S&P has failed to observe the political aftereffects of the debt deal. As I argued previously:
[T]he thing about democracy is that it has multiple ways to constrain political stupidity and ideological overreach. The first line of defense is that politicians will have an electoral incentive to act in non-crazy ways in order to get re-elected. The second line of defense is that politicians or parties who violate the non-crazy rule fail to get re-elected. So, in some ways, the true test of the American system’s ability to stave off failure will be the 2012 election.
The first line line of defense has been breached, but the second line of defense looks increasingly robust. Public opinion poll after public opinion poll in the wake of the debt deal show the same thing — everyone in Washington is unpopular, but Congress is really unpopular and GOP members of Congress are ridiculously unpopular. At a minimum, S&P needs to calculate how the current members of Congress will react to rising anti-incumbent sentiment. If they did that analysis and concluded that nothing would be done, I’d understand their thinking more. I didn’t see anything like that kind of political analysis in their statement, however.
In the end, I suspect Moody’s and Fitch won’t follow S&P’s move, so this could be a giant nothingburger. Still, if these guys are going to be doing political risk analysis, it might help to actually have some political scientists on the payroll. Based on their statement, S&P is simply extrapolating from the op-ed page, and that’s a lousy way to make a political forecast.
I think this is pretty spot on. The general assumption amongst DC insiders and pundits has been that when the Bush Tax Cuts are set to expire, some deal will be reached where the tax cuts for those making over 250k a year will expire, but the tax cuts for those making less will be extended. This is important because while the tax cuts for the wealthy expiring would be somewhat helpful in cutting the deficit, letting all the tax cuts expire has a HUGE effect. S&P, in their analysis, assumes the that the majority of the tax cuts will be extended. But in the same downgrade note they stress that the reason that revenues can’t be raised, and spending can’t be cut is gridlock. They can’t have it both ways though. The facts are that the debt ceiling wasn’t breached, a deal was reached to cut spending, and if there is a greater chance of gridlock going forward, that will only give the administration cover in letting ALL of the Bush Tax Cuts expire.
And then there’s the question of the Tea Party. Alot of talk is about the risk they represent in resisting deals they don’t like and pushing the nation into a default the next time negotiations like these come around, S&P specifically referenced this factor in their downgrade. Felix Simon:
The US does not deserve a triple-A rating, and the reason has nothing whatsoever to do with its debt ratios. America’s ability to pay is neither here nor there: the problem is its willingness to pay. And there’s a serious constituency of powerful people in Congress who are perfectly willing and even eager to drive the US into default. The Tea Party is fully cognizant that it has been given a bazooka, and it’s just itching to pull the trigger. There’s no good reason to believe that won’t happen at some point.
But here’s Kevin Drum of Mother Jones throwing some cold hard facts on that conventional wisdom:
I hate to let anyone one-up me in my contempt for the absurd stranglehold the Tea Party holds over John Boehner and a cowering GOP, but this really, really just isn’t true. Yes, there were a few tea party-ish lunatics in Congress who apparently intended to vote against a debt ceiling increase no matter what. About 20 or 30, I think. And yes, the Tea Party contingent brought us to the brink of a partial government shutdown, which would have been bad news for the economy.
But in the end — and no one who has even a nodding acquaintance with political history should be surprised that it took until the 11th hour — a deal was cut. What’s more, even if a deal hadn’t been cut by August 2nd, we wouldn’t have defaulted on our debt. A bunch of government services would have been temporarily put on hold, but bondholders would have been completely unaffected. This is a really important point. It’s true that a temporary government shutdown would have been bad, but this has happened before. It’s ugly and stupid and unnecessary, but it’s politics. America’s debt, however, was never at any risk.
On a similar note, here’s Ezra Klein:
S&P is downgrading their estimation of our political system, not our actual ability to pay our debts….Of course S&P is downgrading our political system. Did you see the nonsense we pulled over the past few months?….Why shouldn’t S&P downgrade our debt?
Answer: because S&P shouldn’t be in the business of commenting on a country’s political spats unless they’ve been going on so long that they’re likely to have a real, concrete impact on the safety of a country’s bonds. And that hasn’t happened yet. There’s no serious macroeconomic reason to think America can’t service its debt and there’s no serious political reason to think the Tea Party has anything close to the power to provoke a political meltdown in which we won’t pay our debt.
Look. The United States has been running up big debts for the past couple of years because we’re trying to climb out of an epic recession: jobs and economic recovery are exactly where our fiscal spotlight should have been. As a result, we’ve been focusing on our long-term debt for, literally, less than a year. Pretending that our political system is fundamentally broken because we haven’t solved our long-term entitlement problems in a few months is staggeringly panicky and ahistorical, and S&P’s weird obsession with hitting a $4 trillion target for medium-term deficit reduction is economically vacuous. If we still can’t get our act together in four or five years, then fine. We deserve a downgrade. But a few months? That’s crazy. It’s the kind of hair-trigger reaction that belongs on cable shoutfests, not in the boardroom of a sober, 150-year-old financial firm.
So maybe S&P is trying to outsmart everyone, and they know that their downgrade makes it more likely that all the tax cuts expire in 2012, and maybe they know that gridlock will help, not hurt that proposition. Who knows? I have no idea what the reaction will be to this downgrade. But I think once the practical aspects of this downgrade are figured out in the next day or two, the market’s focus will be back on what it should be on, economic growth concerns and an actual immediate debt concern over in the PIIGS, not on S&P’s op-ed page type analysis. The markets knew that a debt ceiling deal would be reached in the 11th hour and acted accordingly. The bond market has been signaling growth concerns for the past 6 months, not concerns over debt. It also has been right. I’ll be watching the markets, not the ratings agencies.