Missed in the Downgrade Hubbub - No Entitlement Reform

For all the blame of the tea party has taken for the recent debt downgrade, the real culprit was lost in the news. The S&P report is remarkable mostly for stating the obvious. That the President would issue excuses and denials is more evidence, as if we needed it, of his lack of leadership.

The money paragraph from the S&P report:

The political brinksmanship of recent months highlights what we see as America's governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed. The statutory debt ceiling and the threat of default have become political bargaining chips in the debate over fiscal policy. Despite this year's wide-ranging debate, in our view, the differences between political parties have proven to be extraordinarily difficult to bridge, and, as we see it, the resulting agreement fell well short of the comprehensive fiscal consolidation program that some proponents had envisaged until quite recently. Republicans and Democrats have only been able to agree to relatively modest savings on discretionary spending while delegating to the Select Committee decisions on more comprehensive measures. It appears that for now, new revenues have dropped down on the menu of policy options. In addition, the plan envisions only minor policy changes on Medicare and little change in other entitlements, the containment of which we and most other independent observers regard as key to long-term fiscal sustainability.

Parsing this, there are four problems, all obvious.

1. The two political parties are far apart in their philosophical differences on how to deal with the the federal government's liabilities. I wrote that the voters will have to decide in 2012. Maybe they won't. This is a reasonable cause for downgrade, because uncertainty exists. Tea partyers, we need to keep the pressure on and push the election of those who will get serious about debt reduction.

2. Only modest savings were agreed to. Sounds like a tea party position to me. And we get the blame? Of course only modest savings were agreed to, because big savings require political consensus that is still lacking, see paragraph 1.

3. New revenues are needed. Before you expel me from the tea party for agreeing, let me state the manner in which I agree. New revenue does not mean new taxes, even if that's what S&P meant. Reform of the personal and corporate tax code to close loopholes, special favors and incentives, while reducing rates in a manner that would be scored as revenue neutral would in fact increase revenue. This is because in a dynamic economy, rather than the static one envisioned by the CBO, the misapplication of resources caused by the tax code will cease. This will in turn increase economic output. Further, corporations will spend less on tax compliance, releasing those resources for investment and hiring. What about the armies of unemployed tax lawyers you might ask. Really? Did you ever meet an unemployed lawyer? And if you did, how is that a bad thing? Further, rolling back Obamacare and other anti-jobs recent regulation will also increase revenue. All with lower tax rates.

4. And the big money issue: only minor changes in entitlements. Structural changes to social security, medicare and medicaid are necessary for fiscal solvency as they form about half of all federal expenditures. Somehow they are off limits, according to Democrats. In a future article, I intend to propose ways to "save" these programs by reducing their costs all while wrapping the pitch in lefty rhetoric.

This is all obvious; we don't need a panel of analysts with PhD's in economics to realize that the debt issued by the United States is less solid than it once was. The most likely outcome is that the government will give current investors a "haircut" through inflation/devaluation of the currency. If you don't think that's likely, you didn't live through the 70s. The only real question in my mind is how low should the rating go. If we are evaluating the risk to our capital by buying long term treasuries, and inflation could easily erode that capital, maybe AA+ is too high a rating.