The contention of the proponents, that the tax rate cuts would more than pay for themselves, was influenced by a theoretical taxation model based on the elasticity of tax rates, known as the Laffer curve. Arthur Laffer's model predicts that excessive tax rates actually reduce potential tax revenues, by lowering the incentive to produce; the model also predicts that insufficient tax rates (rates below the optimum level for a given economy) lead directly to a reduction in tax revenues. The central article of faith in the "Reagan Revolution" was that money rerouted from the poor to the rich would produce a burst of productivity and economic growth. Give to the corporations and the wealthy, said the "supply side" economists, and they will invest the money in new factories, research and technology, and the country will be restored to greatness.
Including costs for fighting in Iraq and Afghanistan, defence spending under Bush has gone up 86 percent since 2001Before the September 11, 2001 attacks, the George W. Bush administration projected in the 2002 budget that there would be a $1.288 trillion surplus from 2001 through 2004.In the 2005 Mid-Session Review this had changed to a projected four-year deficit of $851 billion, a swing of $2.138 trillionThe latter document states that 49% of this swing was due to "economic and technical re-estimates", 29% was due to "tax relief", and the remaining 22% was due to "war, homeland, and other enacted legislation”
An economic recession affects the federal deficit in several ways
So as to enable the treasury to continue issuing treasury holdings for creditors to buy.
Bipartisanship is a political situation, usually in the context of a two-party system such as the United States, in which opposing political parties find common ground through compromise.It cuts federal spending by more than the amount of the debt ceiling increase; and the deficit reduction plan does not include tax increaseswhich House Speaker John Boehner said gives Republicans “the best shot that we’ve had in 20 years ... to put the kinds of fiscal handcuffs on this Congress that are sorely needed.”But preventing a government default was the most persuasive argument for voting for the billCongress to pass a balanced budget amendment to the constitution as a condition for raising the debt ceiling again next year.
While the foreign debt had been cheaper than domestic debt, with the US treasury papers themselves now witnessing a higher rate, the borrowing cost will get expensive as international bonds are linked to US treasuries.
To pay its bills, which includes the salaries of federal employees, federal programs such as Social Security and Medicare, and principal and interest payments to bondholders.
The debt ceiling is the amount of gross debt the federal government can have
The debt limit is written into law, and any increases must be codified in new legislation by Congress and signed by the President
Origin Federal Debt Limit
Second Liberty Bond Act of 1917 –Finance the United States’ entry into World War I
Issuing of long term Liberty bonds – lowering down interest costs.
In 1939, Congress eliminated separate limits on bonds, which created the first aggregate limit that covered nearly all public debt
The Treasury could choose to issue debt instruments with maturities that would reduce interest costs and minimize financial risks stemming from future interest rate changes given the conditions in financial markets.
William Gibbs McAdoo, the Secretary of the Treasury 1917
Defence spending is the big driver but hardly the only one
Homeland security spending also has soared post 9/11
Education spending, up 18% annually since 2001-Bush's No Child Left Behind Act.
The 2002 farm bill, caused agriculture spending to double its 1990s levels
2003 Medicare prescription drug benefit - whose 10-year costs are estimated at more than $700 billion.
2005 highway bill, which included thousands of “earmarks,” stuck into the legislation by individual lawmakers without review, cost $295 billion.
Economic Slowdown & Federal Debt At the end of 2008, that debt equalled 40 percent of the nation's annual economic output (a little above the 40-year average of 37 percent). The sharp rise in debt after 2008 stems largely from lower tax revenues and higher federal spending related to the severe recession and persistently high unemployment in 2008–11
Falling prices of many assets and equities can sharply reduce federal revenues
More difficult economic conditions may reduce tax revenues on earned income and other income sources
“Automatic stabilizers” such as unemployment insurance etc pay out more money as unemployment rises
Deficit spending, can help accelerate inflation if output levels are near or at potential levels
Events leading to 2nd August 2011 Jan 6, April 4 & May 2,2011 : The US treasury sends three letters requesting an increase in the current US debt ceiling. Jan – April 2011 : Moody’s and S&P put USA’s AAA rating on “negative outlook” from “stable”. May 16,2011 : US hits $14.3tn debt ceiling & Treasury secretary Tim Geithner urges Congress to raise limit. May 16,2011 : Payments into two federal pension funds were suspended allowing US to avoid a default before 2nd August 2011 – the Deadline. May 31, 2011 : The US House of Representatives rejects a bill to raise the Debt Ceiling Limit by 2.4 Trillion with 97 favoring it and 318 opposing it. Tim Geithner – Treasury Secretary
Proposed Solutions The Democrats The Republicans
Dollar-for-dollar deal – raise the debt ceiling to match corresponding spending cuts
More of the budget cuts in the first two years
Balanced Budget Amendment – to pass Congress and be sent to states for ratification
No tax increases – tax reform could be considered
Initially wanted an unconditional raise to the debt ceiling with no spending cuts
Spending cuts combined with tax increases on some categories of taxpayers, to reduce deficits.(1:1 spending cut / tax increase ratio initially desired in the Congress, 3:1 offered by President Obama
Large debt limit increase to support borrowing into 2013
Opposed to any major cuts to Social Security, Medicare, or Medicaid
Bypassing the Debt Ceiling
Fourteenth Amendment :
Tim Geithner suggested that the President could declare that the debt ceiling violates the Constitution and issue an Executive Order to direct the Treasury to issue more debt
Minting coins in extremely high denominations
US law does not place a limit on the denomination of minted coins, and specifically mentions that the Mint can create platinum coins of arbitrary value under the discretion of the Secretary of the Treasury
The Secretary of the Treasury is still authorized to monetize 8,000 tons of gold, valued under the old law at approximately $42 per ounce, but with a market value worth over $1,600 per ounce
Influence of Tea Party : Debt Ceiling Tea Party Movement John Boehner
American populist political movement
It endorses reduced government spending, opposition to taxation in varying degrees, reduction of the national debt and federal budget deficit
Short-Term Plan Raise the debt limit in two different votes, one now, cutting spending by about $900 billion and another vote next year before the general elections. There are no tax increases that are a part of this plan Many of the Freshman class, buoyed by the Tea Party, argue they will not agree to raising the debt limit if their demands of major spending reductions are not met. Members of the Tea Party argue that claims about the repercussions of not raising the limit are over-hyped and simply "fear mongering."
“Senate Plan” Democratic core principles Protecting Medicare, Medicaid and Social Security Provide the long-term extension of the debt ceiling Republicans' two major demands : It contained no revenues The amount of the cuts met the amount of the debt ceiling increase. Click on the Image to see this video
Bipartisanship in US Debt Ceiling The House voted 269-161 on a bipartisan, compromise measure to raise the ceiling while cutting government spending Satisfied two key goals of Republicans Some Disappointments Democrats Unbalanced : Cut spending without raising revenue Not one red cent from American’s Wealthiest Families The bill also requires Congress to vote on a constitutional amendment to balance the budget Freshman Republicans Balanced Budget Amendment Door to higher taxes and Defence cuts on the table Democratic Core Principles were also protected
The agreement cut spending more than it increased the debt limit - $917 billion would be cut over 10 years in exchange for increasing the debt limit by $900 billion.
Establishment of Congressional Joint Select Committee - cut at least $1.5 trillion over the coming 10 years
Congress must vote on a Balanced Budget Amendment between October 1, 2011, and the end of the year.
The debt ceiling may be increased an additional $1.5 trillion if either one of the following two conditions are met:
A balanced budget amendment is sent to the states
The joint committee cuts spending by a greater amount than the requested debt ceiling increase
The national debt rose $238 billion on August 3, the largest one-day increase in the history of the United States
The US debt surpassed 100 percent of GDP for the first time since World War II joining Japan , Greece etc. The NASDAQ, ASX, and S&P 100 lost up to four percent in value
On August 5, 2011, Standard & Poor's credit rating agency downgraded the long-term credit rating of the United States government for the first time in its history, from AAA to AA+
The downgrade started a sell-off in every major stock market index around the world,threatening a stock market crash in the international markets
Implications : Dollar A shrink in demand for U.S. Treasuries would push down the value of the dollar relative to foreign currencies While many U.S. exporters would benefit from currency depreciation because it would increase foreign demand for their goods, the same firms would also bear higher borrowing costs from rising interest rates. Threat to the Reserve Currency Status A potential long-term concerns that persistent volatility of the dollar will add force to recent calls by the international community for an end to its status as the world's reserve currency
Wake up and suddenly demand higher rates to keep lending America money, and thus raise our cost of borrowing, which would lead us to higher government deficits and thus even more borrowing. Interest Rates would rise .
Japan and China especially, which have so long found U.S. bonds the safest place to store their growing wealth, would withdraw and start to charge a premium to buy securities..
Market Driven Phenomenon
Selling the U.S. bonds already out there in the market, forcing the government to hike its interest rate offer to get investors to make new loans, that is to buy new bonds.
Weakening of the Dollar
Implications : India
India’s exposure to US debt stands at US$ 41 billion. We are ranked at 14th position in terms of country having exposure to US debt
There would be some short term impact in terms of slowdown in foreign direct investments into India and weakening global equities could put pressure on the Indian rupee.
Force Indian companies to put their foreign fundraising plans on the back burner
There would be a decline in crude oil prices which may help in bringing down India’s stubborn inflation
Role of China Treasury put China’s holdings of US debt at nearly $US1.2 trillion.
Predictions Concerns about the ability of the US to repay its debts, and the impact it will have on US government spending. No signs of US Economy picking up “Tight Fiscal Policy combined with loose Monetary Policy” A loose monetary policy is certain to exacerbate the problem of excess Liquidity US dollar to remain weak. Commodity Prices to continue to rise US cannot afford another bailout action if a new financial crisis erupts as it adopted in response to the global financial crisis of 2008 The Outlook for global markets is not bright
Thank You Anuj Modi Anukool Kumar Neha Bhutani Nikhil Singh Pallavi Behl