How the U.S. Can Get Its Triple-A Rating Back

Credit rating agency opinions always provide the steps a company or government needs to take in order to improve its grade. Standard & Poor’s rating action on the U.S., which downgraded the country’s long-term debt from AAA to AA+ on Friday, August 5, 2011, includes the information that the U.S. needs to consider to recover its AAA rating.

24/7 Wall St. analyzed this report and found that the recommendations of S&P fall into a few categories. First among these is that national debt as a percentage of GDP must decrease from its current level of 74%.  The rating agency will need to be convinced that this will continue over the next decade. S&P also says the budget savings and increases in government receipts must be greater than those that came out of the compromise the two political parties just agreed to prevent a default. Directly related to that, the Congressional Joint Select Committee on Deficit Reduction, which is charged by November of this year to cut another $1.5 trillion, spread out over the next decade, would have to make major cuts in the largest entitlement programs.

In the future, S&P indicates, Congress and the Administration will have to choose expense reductions in the largest entitlement programs, which would be in the hundreds of billions of dollars spread out over the next 10 years. S&P has already rebuked the political system that prevented the Administration from  increasing taxes to begin to balance the budget.  This rating agency made it clear that budget cuts alone are not sufficient but that taxes must be increased in order for the U.S. to regain its former credit rating. The most critical issue raised by the rating agency is that the federal government would need to create a framework to address the costs of an aging American population.

S&P did not factor in to its decision the possibility that the U.S. economy could make a sustained and robust recovery. If that happened, the nation’s budget problems would not disappear, but could improve enough so that the severe strain of entitlement costs might be delayed by a few years.

S&P’s concerns can be divided into two categories that subsume almost all others. The first is that Americans are growing old and the consequent increases in entitlement costs cannot be sustained alone by the current tax collections for programs like Social Security. The young cannot take care of the old anymore, at least based on the level at which those under 40 are taxed for entitlements. Debt as a portion of GDP will worsen, in part,  because there is no vision for a new way to provide some level of basic support for the elderly. This vision could require an increase in the age at which Social Security and Medicare benefits could be accessed and the exclusion of people who have savings or jobs from both of these programs.

It may take a financial catastrophe–a day when America actually cannot raise money in the global capital markets–for voters to acquiesce to real austerity and higher taxes. The most radical analysts of America’s financial future believe that the U.S. will have to look like Greece does today before voters act to salvage the nation’s financial future.

There is a single argument that voters may use to dodge responsibility for America’s credit status. U.S. GDP could begin to surge as it did in the 1996 to 2000 period, when the average annual improvement was over 4%. That seems improbable because recent U.S. GDP growth has been less than 2%. Some economists still believe that overseas demand for American goods and services, along with an improvement in employment prospects in the U.S., will drive U.S. growth much higher again. That means the ability of GDP to rebound is based on both global economic factors as well as American policy. More rapid growth in the U.S. economy might put off the day when the government will face severe debt problems, but debt is still 74% of GDP, and even with strong growth, government expenses will keep that number high. In other words, voters still will have to decide what will become of entitlement and taxes, even if 2% GDP growth accelerates.

S&P probably will do nothing to the country’s new AA+ rating soon, although its analysis warns that there could be another downward revision in the next 12 to 18 months. The agency likely will wait to see the results of the 2012 election. Based on who is sent to Washington and who is sent home, voters will make the only significant determination about whether the U.S. gets its AAA rating back.

The S&P has created a reasonable road map for the U.S. to get its AAA rating back that conforms with the opinions of the majority of economists.  There are a limited number of actions that the U.S. can take, and each will involve some level of sacrifice.

The other crucial area of concern from the S&P revision  is that budget cuts alone are not enough to make sharp deficit reductions. Additional revenue to the Treasury will be needed, which means taxes will have to increase.

Politicians, the media, and economists have all offered detailed solutions for deficit reduction and improving America’s financial fortunes. Most of these can be matched  to S&P’s criticisms:

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