Moody’s warns on tax cut deal

December 14, 2010, 7:09 PM UTC

Moody’s is the latest to warn that the tax deal could imperil the United States’ fiscal position.

The rating agency said in a report Monday that last week’s agreement between the White House and congressional Republicans should bolster economic growth in the next two years – but at the expense of the nation’s already perilous budget position down the road.

Picture of profligacy?

The agreement to extend the Bush tax cuts for two years and trim workers’ payroll tax contributions for one could raise the U.S. debt-to-GDP ratio at 2012 to 72-73% from around 62% now, Moody’s said. It said that without the tax package, that number might have been around 68% in 2012.

Another problem is that under the tax cut package, the ratio of the government’s outstanding debt to its annual tax take will decline less sharply, to just under four times. Moody’s called that “a very high ratio,” both historically and compared to other highly rated government debt issuers.

It warned that unless Congress gets its act together, it could see a once unthinkable downgrade of the U.S. credit rating on its watch, which could balloon U.S. borrowing costs and make our financing position much more costly.

“Unless there are offsetting measures, the package will be credit negative for the US and increase the likelihood of a negative outlook on the US government’s Aaa rating during the next two years,” Moody’s said.

The comment comes as the bond market seems to have reached very much the same conclusion. The yield on the 10-year Treasury has soared to 3.32% from around 2.4% two months ago, as investors bet on a stronger recovery and rising inflation.

But that is still a historically low level (see chart, right), and there are still a lot of forces lined up in favor of lower bond yields. Consider, for instance, the massive debt weighing on a slack economy that helping to keep inflation under wraps.

The risk Moody’s is warning of is of a loss of confidence in the U.S. policymaking apparatus — a fear that doesn’t seem too far fetched at the moment.