Eye on the News

Nicole Gelinas
GOP, Beware the S&P
The ratings agency would be just as happy with tax hikes as with spending cuts.
18 April 2011

Stock markets tumbled this morning after the ratings agency Standard & Poor’s revised its outlook on America’s triple-A credit rating from stable to negative. Republicans might think that S&P’s blockbuster announcement is good news for them politically—but they’d be wrong.

Standard and Poor’s delivered its warning in a press release. The agency could cut the United States’s credit rating in the next few years if President Obama and Congress can’t agree on how to fix the country’s big deficits. These gaps between revenues and spending, S&P noted, are “already noticeably larger” than those of other AAA-rated countries. “More than two years after the beginning of the recent crisis, U.S. policymakers have still not agreed on how to reverse recent fiscal deterioration or address longer-term fiscal pressures,” said analyst Nikola Swann.

No one knows what would happen if ratings agencies followed through on this warning and cut the nation’s credit score. Textbook economics hold that it would push our borrowing costs up, because global bondholders would consider America to be more likely to default on its debt. Japan, though, has a AA- rating, three “notches” below America’s, thanks to debt levels that far exceed ours—and Japan has never had much trouble borrowing for cheap. And if markets begin to worry, they could drive our borrowing costs up well before S&P officially cuts the U.S. rating. In several debt crises over the past decade, including Europe’s government-bond crisis, markets have often acted before ratings agencies.

Some Republicans, however, think that the politics of S&P’s downgrade warning are pretty obviously in their favor. Their reasoning is easy to understand: the global scrutiny that S&P’s announcement brings will pressure President Obama and congressional Democrats to cut a fast deal on spending and entitlements along the lines of what Rep. Paul Ryan suggested last week.

“As S&P made clear, getting spending and our deficit under control can no longer be put off for another day,” said House Majority Leader Eric Cantor earlier today. “House Republicans will only move forward on the President’s request to increase the debt limit if it is accompanied by serious reforms that immediately reduce federal spending and end the culture of debt in Washington.”

But Standard and Poor’s is not on the Right’s side, and Republicans should be wary about embracing its seeming fellowship. Over the past decade, in its ratings of state and local debt, S&P and its rivals have expressed no preference between tax hikes and spending cuts. Indeed, the credit-raters often see big tax hikes as a sign of bold political leadership.

In January, for example, after Illinois hiked personal and corporate taxes to address its budget deficit, S&P removed the Prairie State from a negative “watch” (a more serious condition than the new negative “outlook” on the U.S.). In doing so, the raters said that “revenue measures that [the state legislature] expects will provide between $6 billion and $7 billion in recurring revenue,” plus new borrowing for pensions, had provided for “structural budget solutions” and could “provide a foundation for structural budget balance in the future.” Ratings agencies have made similar pronouncements in the past when New York State and City have raised taxes.

The raters may be even more sanguine about tax hikes at the national level. People can move from state to state more easily than they can from nation to nation, leaving them more captive to federal policies. Moreover, S&P compares us with our international AAA-rated “peers,” many of which levy higher rates of taxation on wealthier earners and on investment capital.

In today’s announcement, S&P said outright that “it takes no position on the mix of spending and revenue measures the Congress and the Administration might conclude are appropriate.” But, the agency continued, “for any plan to be credible, we believe that it would need to secure support from a cross-section of leaders in both political parties.”

Congressional Republicans should be careful, then, about seizing on the S&P announcement as fodder for their political arguments. After all, President Obama would consider his plan—spending cuts and tax hikes—to be the “credible” compromise. Many top folk in the banking industry, themselves beholden to the federal government for continued “too-big-to-fail” support, would agree.

Republican strategists need only look to recent history to see the risk they run should they tightly embrace the S&P verdict. Almost two years ago, S&P cut its outlook on Britain’s AAA rating, for the same reasons it has now cut America’s: debt and deficits.

Britain’s incoming Conservative Party seized on this “market” conclusion as evidence that it had to raise taxes, and quickly. The Conservative-led coalition government increased taxes on VAT earlier this year, from 17.5 to 20 percent, dampening retail sales. It also went ahead last year with former prime minister Gordon Brown’s plan to hike the top personal-income tax rate to 51 percent (compared with America’s top rate of 35 percent). Though Britain has promised spending cuts, those cuts remain mostly in the future. Yet the Conservatives have reaped a political reward. S&P last year returned their nation’s outlook to “stable.”

Nicole Gelinas is a contributing editor to the Manhattan Institute’s City Journal and author of After The Fall: Saving Capitalism from Wall Street—and Washington.

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