The bipartisan debt Supercommittee is expected to announce Monday that after three months it has hit gridlock on finding spending cuts to bring down a record federal deficit, which now stands at $15 trillion, equal to the size of the U.S. economy.
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But the failure will not immediately trigger another round of downgrades to the U.S. debt rating. That’s because of the automatic debt triggers baked into the deal, where Congress must cut $1.2 trillion over 10 years, or $120 billion a year, starting in 2013.
Republicans are already sounding out the idea of even reining in those $1.2 trillion in automatic cuts, however, because they want to lessen $600 billion in defense cuts from the triggers. And cuts and tax reform are notably difficult to enact in a presidential election year.
Whether the credit ratings agencies sit tight until 2013 or beyond and don't downgrade the U.S. debt rating is an issue sure to give the financial markets indigestion.
And separate from all that, Congress still has a lot of work to do. It faces several other looming deadlines on measures that Democrats say are critical to economic growth, measures which could also face similar failure. (There is only about one month to go on the legislative calendar, notes Trish Turner, FOX News senior Capitol Hill producer.) Chief among them are linchpins of the President’s stimulus measures, including the extension of unemployment benefits and payroll-tax cuts. Turner says, citing Capitol Hill sources, that “some conservative GOPers have called for reforming” the unemployment system first, so expect a fight here.
Congress must also grapple with a host of other tax breaks important to business growth that need to be extended, for things like corporate research and development. This is the so-called "tax extenders" fight that happens each year, Turner says.
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Turner also points out that Congress will need to stop doctors “from being hit with a whopping cut” to their federal Medicare reimbursement payments, the so-called “annual 'doc fix’ fight.”
And Congress will need to "patch" the dreaded alternative minimum tax, “so middle class taxpayers aren't swallowed up by it,” Turner says.
The expectation was that the committee would take care of all these measures in a debt deal that optimistically would have moved through Congress by December 23.
But now, Congress is nearing the end of its session, and it “has only approved three of 13 annual spending bills,” with just about a month to go, says Turner. The current continuing budget resolution which funds the federal government runs out December 16.
How will the rating agencies react to all of this?
The first to watch is Standard & Poor’s, which has already dropped the U.S. credit rating to double A-plus. That’s below France and Germany, and veering toward the double-A territory of China or Japan.
S&P has told FOX Business it wants at least $4 trillion in cuts over the next 10 years, as well as a credible plan to stabilize the deficit. Without these things, it has threatened to drop the U.S. to double-A. S&P continues to keep the U.S. rating on negative watch, as does Moody’s Investors Services. Fitch Ratings has a stable outlook on the U.S.’s triple-A rating. That means it would first revise that outlook to negative before it actually downgrades the rating.
Wall Street economists and analysts fear the United States may see another ratings cut, possibly as soon as the end of this year. That’s what Ethan Harris, Bank of America Merrill Lynch’s economist for North America, forecast in a recent report.
Harris notes the credit rating agencies have said Congress must come up with a credible long-term plan to cut the deficit. If it does not, "we expect at least one credit downgrade in late November or early December when the super committee crashes," he wrote.
Moody's, though, has said it is looking at several other factors before rendering its decision on the U.S. rating, including the results of presidential elections and the expiration of the Bush-era tax cuts late in 2012.
Key to the debt rating is economic growth.
Growth in U.S. gross domestic product is likely to be in the range of 2% over the next several years, says economist Peter Morici. He warns, though, that “such slow growth and high unemployment will accelerate spending on entitlements while retarding the growth of tax revenues.”
However, a double dip isn’t on the horizon, says Morici, thanks to slightly higher growth prospects, according to a recent survey by the National Association for Business Economics. U.S. gross domestic product is expected to grow 1.8% this year, more than a September forecast of 1.7%, and that grows to 2.4% in 2012.
But “even with somewhat more robust growth, Medicare, Medicaid and veterans' benefits costs will outpace the government's ability to raise revenue, because prices in health care rise so much faster than elsewhere in the economy,” Morici warns.