Sunday, July 17, 2011

Financial Heavyweights Tell G.O.P. to Raise Taxes -- But They're Not Listening

As the president and Congressional Republicans squabble over how to avoid a default on the nation's financial obligations, the financial world's heavy hitters are increasingly signaling that they want the G.O.P. to embrace the $4 trillion "Grand Bargain" preferred by Barack Obama, including revenue increases that some Republicans consider politically suicidal. Yet G.O.P. lawmakers don't seem to be listening, steering instead toward a politically easier solution that appeases the Tea Party but may not be enough to avoid economic catastrophe.

Late Thursday, the credit-rating agency Standard & Poor's released a statement announcing that merely raising the debt ceiling will not be enough to prevent a downgrade of the United States' credit rating for the first time in seventy years, potentially causing the interest rate on both government and private debt to skyrocket and destabilizing the entire economy. Remarkably, the statement also prescribed the specific numbers and conditions that would allow the U.S. to avoid such a catastrophe: to ensure a stable credit rating, any deal between Obama and the Republicans must reduce debt by $4 trillion, should include some "mix" of spending cuts and tax increases, and must involve concessions by both sides (a strong hint that the G.O.P. must consider closing tax loopholes, as well as a repudiation of Eric Cantor's assertion that merely attending negotiations is the only concession the GOP intends to make).

In short, Standard & Poor's has put G.O.P. lawmakers on notice that if they take the easy way out instead of making the "Grand Bargain" that Obama has advocated for, including tax increases, they may be responsible for disrupting the U.S. economy.

The S&P statement clearly states that merely raising the debt ceiling, or implementing a deficit-reduction package in the $1-2 trillion range, will not be enough to prevent a costly rating downgrade, because it would show that the country is not serious about tackling the deficit:

"U.S. political debate is currently more focused on the need for medium-term fiscal consolidation than it has been for a decade. Based on this, we believe that an inability to reach an agreement now could indicate that an agreement will not be reached for several more years. We view an inability to timely agree and credibly implement medium-term fiscal consolidation policy as inconsistent with a 'AAA' sovereign rating...."

Standard & Poor's bombshell capped a week filled with communiques from the financial world telling politicians in general to stop posturing and Republicans in particular to be more flexible on taxes. On July 7, a blistering editorial in The Economist  took Republicans to the woodshed:

"[T]he Republicans are pushing things too far. Talks with the administration ground to a halt last month, despite an offer from the Democrats to cut at least $2 trillion and possibly much more out of the budget over the next ten years. Assuming that the recovery continues, that would be enough to get the deficit back to a prudent level. As The Economist went to press, Mr Obama seemed set to restart the talks.

"The sticking-point is not on the spending side. It is because the vast majority of Republicans, driven on by the wilder-eyed members of their party and the cacophony of conservative media, are clinging to the position that not a single cent of deficit reduction must come from a higher tax take. This is economically illiterate and disgracefully cynical."

The Economist even advocated for the tax hikes that Obama has demanded (and which many House Republicans have staked their political careers on refusing):

"This newspaper has a strong dislike of big government; we have long argued that the main way to right America’s finances is through spending cuts. But you cannot get there without any tax rises. In Britain, for instance, the coalition government aims to tame its deficit with a 3:1 ratio of cuts to hikes. America’s tax take is at its lowest level for decades: even Ronald Reagan raised taxes when he needed to do so.

"And the closer you look, the more unprincipled the Republicans look. Earlier this year House Republicans produced a report noting that an 85%-15% split between spending cuts and tax rises was the average for successful fiscal consolidations, according to historical evidence. The White House is offering an 83%-17% split (hardly a huge distance) and a promise that none of the revenue increase will come from higher marginal rates, only from eliminating loopholes. If the Republicans were real tax reformers, they would seize this offer."

Last Tuesday, nearly 500 U.S. business leaders, including solidly conservative groups like the U.S. Chamber of Commerce and the Financial Services Forum, signed a letter urging both sides to make "hard choices" to adopt a long-term solution, not just a temporary extension of the spending cap. The next day, the rating agency Moody's also warned of a downgrade unless lawmakers negotiated a "substantial and credible" debt-reduction deal.

Thursday, as Obama dismissed negotiators to decide over the weekend how they wanted to proceed, Standard & Poor's issued its warning to the federal government, then followed Friday with additional warning that it also may downgrade the credit ratings of several blue-chip financial firms that are heavily invested in U.S. Treasuries, including New York Life Insurance Co. and Northwestern Mutual Life Insurance Co., simply because "no financial institution can carry a higher rating or outlook than its sovereign," and those of some other financial services organizations (including Federal Home Loan and Farm Credit System banks and the mortgage loan guarantee companies Fannie Mae and Freddie Mac) that have "direct links to, or reliance on, the federal government." Those warnings are likely to reverberate into the rest of the financial sector over the coming week.

Standard & Poor's remarkably prescriptive warnings, which sound more like World Bank admonishments to a fiscally irresponsible Third World nation than an assessment of the most secure investment on Earth, would seem to be the final blow to beleaguered Republicans' ability to resist any semblance of new taxes. And some senior Republican statesmen have, indeed, been trying to educate the party's junior members about the seriousness of the problem. Former Senate Budget Committee chairman Pete Domenici, who helped negotiate the nation's last balanced budget under President Bill Clinton, has teamed with former George H.W. Bush Treasury undersecretary Jay Powell to issue a report saying that tax purists like Minnesota congresswoman Michelle Bachmann are "wrong" and calling for Republicans to embrace some tax hikes. Federal Reserve Chairman Ben Bernanke, originally a Bush appointee, warned House Financial Services Committee that a failure of U.S. Treasury bonds "would throw shockwaves through the entire global financial system."

But the message does not seem to have penetrated the Republican caucus, which appears irreconcilably split between economic pragmatists and anti-tax ideologues and therefore is continuing to pursue economically inadequate, but politically palatable, solutions:

Asked by Obama Thursday to return by Saturday with at least a general idea of what direction they would like to pursue, House Republicans let the deadline slip and instead plan to spend the next week passing a "Cut, Cap & Balance" bill and balanced budget amendment that do not address the immediate problem and have no chance of passing the Democrat-controlled Senate. In the Senate, Minority Leader Mitch McConnell (R-KY) and Majority Leader Harry Reid (D-NV) reportedly are continuing to work on a "hybrid" plan to temporarily raise the cap and enact smaller spending cuts without tax increases -- precisely the sort of plan that Standard & Poor's has said would result in a downgrade of America's debt -- plus a "debt commission" that would consider further deficit reduction measures later, which may or may not demonstrate the kind of "seriousness" that the financial markets say they want. And Senate Minority Whip John Kyl (R-AZ) continues to parrot anti-tax talking points, referring Sunday to the president's "absolute obsession with raising taxes" and "[j]ob-killing taxes." At the other extreme, budget hawk Tom Coburn (R-OK) said Sunday that he will offer a plan that closes some tax loopholes -- but his plan seeks to cut a massive $9 trillion by making punitive reductions to entitlements and social programs, and he acknowledges it stands no chance of passing.

The debt ceiling question has become a proxy war over the soul of the Republican Party, pitting old-school pragmatic conservatives who understand how complex the financial system is against anti-tax and Tea Party ideologues. Wall Street clearly is allying itself with the pragmatists, even if doing so means that Republicans may suffer electoral setbacks in 2012. Rank-and-file Republicans appear to be struggling to decide which of their impulses is stronger: the desire to help the economy recover, or the desire to retain control of the House of Representatives in the face of Tea Party wrath over tax hikes. If they follow their current course, and if Standard & Poor's keeps its promises, they may wind up with neither.


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