Fiscal Cliff Negotiators May Need to Aim Higher

President Barack Obama and House Speaker John Boehner speak to reporters in the White House on Nov. 16, 2012 Photograph by Carolyn Kaster/AP Photo

Even a $5.9 trillion target might not be ambitious enough, say the Bloomberg Government researchers. Lowering the debt-to-GDP ratio to 60 percent—which “is considered a more financially sound level for countries to maintain”—would require $9 trillion in deficit reduction between now and 2022, they say.

This is something that neither Democrats nor Republicans want to hear. Just getting to $4 trillion in deficit reduction is proving politically impossible. Going even bigger is hard to imagine—which is why it’s a good bet that the debt-to-GDP ratio will rise over the coming decade, perhaps substantially.

Complicating matters further, the U.S. economy is too weak now to absorb lots of deficit reduction. Joseph Brusuelas, a Bloomberg economist, writes in today’s Bloomberg Economics Brief that the scheduled tax increases are “likely to have greater impact than generally acknowledged.” That’s because consumers are so tight on cash that they will have to cut back spending by 75 cents for every extra dollar they pay in taxes, Brusuelas estimates. In a healthier economy tax hikes would have a smaller impact on spending. He estimates that unemployment is likely to reach 9 percent by next summer if the fiscal cliff isn’t dealt with.

The fragility of the economy is why Congress and the White House are trying to stop or soften the Jan. 1 fiscal cliff of automatic spending cuts and tax increases. The longer the deficit-cutting pain is postponed, however, the bigger the eventual cuts will have to be to achieve any given amount of savings, whether it’s $4 trillion, $5.9 trillion, or $9 trillion.

The Bloomberg Government analysis may not be well-received in Washington, but it’s well-founded. The organization—a sister to Bloomberg Businessweek at Bloomberg LP—used the the latest macroeconomic assumptions about GDP growth, inflation, and interest rates from the Congressional Budget Office, which is the nation’s official legislative budget scorekeeper.

On a more optimistic note, Bloomberg Government finds in a second report that even $4 trillion worth of deficit reduction would benefit business by reducing interest rates in the long run. It calls this a “rarely acknowledged beneficial impact” of deficit reduction. “Corporations would save at least $60 billion a year in interest payments, and the value of publicly traded companies would increase by $1.1 trillion,” the analysts calculate. That’s assuming a half percent reduction in interest rates. Bigger deficit cuts would cut rates more.

Right now rates are extremely low because the economy is weak, but as the economy recovers, big deficits could push up interest rates as the government sucks up all the available funds from lenders. That’s known in the trade as the government’s “crowding out” of private-sector borrowing.

The research reports are available only to Bloomberg Government subscribers. They are by Robert Litan, the research director; Christopher Payne, senior economic analyst; Tony Costello, lead analyst; and Patrick Driessen, senior tax analyst.

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