Moody's Says Obama Tax Proposal Deal Is Negative for U.S. Credit Rating

Moody’s Investors Service Inc. said President Barack Obama’s agreement to extend tax cuts raises the chance of a negative outlook for the U.S.’s Aaa credit rating unless offsetting measures are enacted.

While the compromise package is likely to boost economic growth in the next two years, it will “adversely affect” the budget deficit, Senior Credit Officer Steven Hess wrote in a note today. Obama’s deal with congressional Republications, announced Dec. 6, calls for a two-year extension of tax rates in return for extending long-term jobless benefits for 13 months and cutting the payroll tax for $120 billion for a year.

“From a credit perspective, the negative effects on government finance are likely to outweigh the positive effects of higher economic growth,” New York-based Hess wrote. “Unless there are offsetting measures, the package will be credit- negative for the U.S. and increase the likelihood of a negative outlook on the U.S. government’s Aaa rating during the next two years.”

The Congressional Budget Office estimates budget deficits of $1.1 trillion for fiscal 2011 and $665 billion for 2012 if tax cuts enacted in 2001 and 2003 expire on schedule on Dec. 31, for a ratio of government debt to GDP of 68.5 percent by the end of fiscal 2012, Hess wrote. The net cost of the compromise package may be $700 billion to $900 billion, pushing the ratio to as much as 73 percent, he wrote.

“Higher economic growth should have a positive effect on government revenues and reduce payments related to unemployment,” Hess wrote. “However, the magnitude of this positive effect will be considerably less than the forgone revenue and increased benefit expenditure.”

There also is a risk that the tax-cut extension may be renewed during the presidential-election year of 2012, which might generate a “considerable increase in deficit and debt levels” unless there are offsetting provisions, he wrote.

Editors: Greg Storey, Paul Cox

To contact the reporter on this story: Cordell Eddings in New York at ceddings@bloomberg.net

To contact the editor responsible for this story: Dave Liedtka at dliedtka@bloomberg.net