Hamish McRae: Ryan is trying to cut US deficit but is it make-believe?
A lot happens in four years and the turning point in global long-term yields is beginning to look overdue
Thursday 30 August 2012
Outlook This week in Tampa is about politics, not economics. We don't know whether Mitt Romney and Paul Ryan will become credible challengers to the Democrats; still less do we know what a change of Administration would result in, in terms of a change of economic direction. But we do know one thing with reasonable certainty. It is that the next presidential term, whoever wins office, will involve fiscal consolidation of some sort. The fiscal deficit will come down: the issue is how fast and by what means.
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So I think the best way to see the Republican convention is as a throat-clearing event, one of many political preludes that will absorb both parties ahead of the serious business to come.
The US "safe-haven" status has enabled difficult decisions to be postponed, for the US can still borrow at historically cheap rates. Yesterday the 10-year bond yield was a mere 1.66 per cent. But all our past experience suggests that this rate is artificial – it is certainly unprecedented – and that the next Administration will have to contend with more normal market circumstances. Nothing is forever, not even bargain-basement interest rates.
Would the Republicans really be different? History suggests that they would be the party of fiscal irresponsibility, not rectitude. It is the Democrats who have, in the past, corrected the deficits. But the choice of Mr Ryan on the ticket has changed things because he presents himself as, and is assumed to be, a fiscal conservative.
While politicians in office are very different to politicians on the stump, it is a reasonable starting point to look at what they actually say. In the case of Mr Ryan it is especially interesting because he proposed in the spring a set of fiscal measures that on the face of it would have cut both spending and the deficit. These were passed by the Republican-dominated House but turned down by the Senate, which is still controlled by the Democrats, a situation that might change in November.
You can see the supposed impact of two sets of plans in the graphs, those of the present Administration and those of Mr Ryan's proposed legislation. In the first you can see how spending would be significantly lower under the Ryan plan than under the present plans of President Obama.
He would aim to cut income and corporation tax rates to a top rate of 25 per cent but would limit the impact of this by closing loopholes, ie by increasing the tax base. But in the second you can see that the Ryan plan only achieves a return to near-balance (not a surplus) if it were indeed to succeed in broadening the tax base. If this were not to happen, the deficit would narrow even more slowly than under the present plans.
These projections come from some calculations by the Tax Policy Center in Washington, a joint venture between the Urban Policy Institute and the Brooking Institution. It strives to be independent, a bit like the UK's Institute for Fiscal Studies. Commenting on these calculations, ING Bank notes that the Republicans would struggle to cut spending by as much as the Ryan plans suggest, and it is difficult to see quite how the tax base could be broadened sufficiently, for tax breaks once established are hard politically to end.
On the other hand it may be that a Republican president would find it easier to deal with a Republican House, which in the short run would make matters easier because Congress has to deal with the so-called "fiscal cliff" at the end of this year, when Bush-era tax cuts automatically expire unless Congress extends them. You could see a deal: accept a tighter fiscal policy in the future in return for extending the tax breaks a bit longer.
You could conclude that in the short term at least, a Republican victory would make for an easier budget settlement. But as an outsider I find myself troubled by all this. For the moment the US retains safe-haven status. It may well keep that for some while to come. But a lot happens in four years and the turning point in global long-term yields is beginning to look overdue.
So the next Administration, whosoever forms it, is likely to face a period of rising interest rates before its four years are out. That will up the pressure on closing the deficit.
The proposals of the Republicans are interesting and important. But there is an element of make-believe about them that, if they were to achieve office, would become exposed by the harsh world of the markets in a couple of years' time.
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