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Tax Cuts will Balloon US Debt to 120% of GDP, but Boost to Economy will be “Short-Lived”

Published: November 7, 2017
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Source: Wolf Street

It’s uncertain what if anything in the mix of tax cuts and tax increases being kicked around in Congress will become law. But Fitch Ratings believes that some combination will make it, and that it will sap US government revenues. “Under a realistic scenario of tax cuts and macro conditions,” the US deficit would rise to 4% of GDP next year, and balloon the US debt to 120% of GDP by 2027.

And that might be the best-case scenario.

That debt-to-GDP ratio just shot up to 105% – based on annualized Q3 GDP of $19.5 trillion and the US gross national debt of $20.5 trillion that had spiked by $640 billion in eight Weeks, following the suspension of the debt ceiling in September. The debt-to-GDP ratio was 103% earlier this year.

Fitch said in the report that it expects some version of the package to pass the US Congress, and that it “will be revenue negative, even under generous assumptions about its growth impact.”

The tax package, which includes cutting the corporate tax rate from 35% to 20%, “would deliver a modest and temporary spur to growth,” Fitch said. Even with these tax cuts, Fitch expects US economic growth to peak at 2.5% next year and then fall back to 2.2% in 2019 – the same kind of economic growth the US has seen since the Financial Crisis. So any boost to output from the tax cuts would be “short-lived.”

These tax cuts would “not pay for themselves or lead to a permanently higher growth rate,” Fitch said, adding:

The cost of capital is already low and corporate profits are elevated. In addition, the effective tax rate paid by large corporations is well below the existing statutory rate.

Throwing in these tax cuts to add to demand “at this point in the economic cycle” could boost inflationary pressures and “lead to additional monetary policy tightening.”

This is something various Fed governors have also suggested. The Fed has already begun the QE unwind, has hiked its target rate four times so far, and is very likely to hike it again in December. More rate hikes are on the menu next year, but for now they’re expected to be few and far between. This could change if inflation, perhaps stimulated by tax cuts or whatever, picks up steam.  Higher rates might follow, which would further increase the government’s cost of funding, the deficit, and the debt.

So the tax cuts “will lead to wider fiscal deficits and add significantly to US government debt.” Fitch added the not very veiled warning concerning the AAA-rating Fitch still maintains on the US:

The US will enter the next downturn with a general government “structural deficit” (subtracting the impact of the economic cycle) larger than any other ‘AAA’ sovereign, leaving the US more exposed to a downturn than other similarly rated sovereigns.

The US is the most indebted ‘AAA’ country and it is running the loosest fiscal stance. Long-term debt dynamics are also more negative than those of peers, with health and social security spending commitments set to rise over the next decade.

At this point, Fitch believes that these weaknesses are still “outweighed” by the “flexibility” the US enjoys in financing its debts – the entire world clamors to buy US Treasuries for now – and by “the US dollar’s reserve currency status.” These two factors combined are still “underpinning” Fitch’s AAA/Stable rating.

These are longer-term considerations that could impact the US credit rating after the tax package takes effect and starts having an impact on deficits and the debt.

Short-term, there is another risk to the AAA-rating: Congress’s “failure to raise the debt ceiling” by the first quarter next year, when the Treasury Department runs out its “extraordinary measures” that allow it to kick the out-of-money date down the road.

The current suspension of the Debt ceiling expires on December 8. Then the debt ceiling charade will be back, along with the brinkmanship among lawmakers to extract from each other some concessions by holding out the possibility of a self-inflicted US default. This makes bondholders and ratings agencies nervous.

But the debt-ceiling charade has some peculiar effects, beyond its entertainment value: For months on end, it covers up the true extent of US government debt, and its continued surge. Then suddenly, the floodgates open. Read…   US Gross National Debt Spikes by $640 billion in 8 Weeks

 

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