The United States must shrink its national deficit by about $3 trillion over 10 years to prevent another recession, according to Moody’s Analytics chief economist Mark Zandi.
The tax increases and spending cuts slated to hit next year equal more than 4.5% of GDP. “An economy growing at 2% can’t withstand this,” Zandi says (click on chart below). “On the other hand, failing to make significant progress toward fiscal sustainability could trigger downgrades by the credit rating agencies and signal to investors that Washington is unable to act without a full-blown crisis.”
“None of this is likely to be politically possible before the November election, nor during Congress’ lame-duck session afterward. But it will become possible early next year,” Zandi says.
If President Obama is re-elected and the House remains under Republican control, the president will likely insist that Congress let the Bush-era tax rates expire for those making more than $250,000 per year.
This would generate $850 billion in tax revenues over the coming decade. With tax rates higher for everyone as 2013 begins, House Republicans will be under increased pressure to go along, Zandi says.
“But Republicans will gain negotiating leverage as the Treasury again nears its debt ceiling,” he adds. “The GOP will likely demand more spending cuts before agreeing to raise it.”
While the resulting tax increases and spending cuts may not total the $3 trillion needed to produce a sustainable fiscal outlook, the result should be close enough to placate investors and address ratings-agency concerns.