Newly emboldened Republicans demanded all the Bush tax cuts be extended. President Obama argued the country couldn’t afford those for families in the highest tax brackets, but failed to apply such reasoning to temporary benefits bestowed on Democratic constituencies by his 2009 stimulus program.
Instead of compromising, with each side getting half of what it wanted, Washington feasted—everyone got everything they wanted and more. Business got its R&D tax credit and a temporary tax holiday on new investments. The wealthy got Bush-era tax rates and even lower rates through temporary elimination of income-triggered phase outs on deductions and personal exemptions. The poor and middle class got a temporary 33 percent cut in social security taxes.
Since Nancy Pelosi became speaker in 2007, government spending and the federal deficit have jumped from 19.6 percent of GDP and $161 billion to 25.1 percent and $1.5 trillion in 2011. Unfunded, increases in health care spending, the regulatory bureaucracy and fanciful experiments in industrial policy—windmills, electric cars and batteries, and the like—have bloated federal spending without credible plans to pay for it all.
Now Congress and the President compound those sins by both enacting additional “temporary” tax cuts that will be very difficult to ever let lapse. For example, thanks to Clinton and Bush tax cuts, the Social Security tax is the principal tax low- and middle-income workers pay—many pay zero or minimal personal income taxes.
In 2012, when the Congress must revisit the personal and corporate tax codes, permanent reductions in Social Security taxes will be politically necessary to win extensions for the Bush tax cuts benefiting even middle income families and the truly essential benefits businesses need to create jobs, not to mention all the additional goodies the Congress has just bestowed.
This renders the Social Security system absolutely insolvent, and makes permanent budget deficits upwards of $1.5 trillion and about ten percent of GDP permanent.
Moody’s would be hard pressed to give any government with budget projections like those an investment grade rating, but the United States is different.
The dollar is the global currency, and Washington can print dollars if no one wants to buy new Treasury securities to pay off maturing bonds and finance new spending.
Nevertheless, long-term U.S. Treasurys are risky investments.
Internationally, interest-bearing Treasurys function much the same as currency on the balance sheets of central banks, multinationals and the wealthy. Whether as Treasurys or currency, too many dollars in circulation will instigate inflation as the global economy recovers.