Dollar Crisis Looms if US Doesn�t Curb Debt: Experts

CNBC (Link) - Reuters (January 13, 2010)

The United States must soon raise taxes or cut government spending to curb its debt, and failure to act will risk a crippling dollar crisis as investor confidence ebbs, a panel of experts said on Wednesday.

�It has got to be done. It will be done some day. It may be done with enormous pain. Or it may be done more rationally,� said Rudolph Penner, a former head of the nonpartisan Congressional Budget office who co-chaired the 24-strong Committee on the Fiscal Future of the United States.

President Barack Obama�s administration will present his budget for fiscal 2011 early next month amid intense pressure to live up to election campaign promises not to raise taxes on middle class Americans, while confronting a record deficit.

As a result, Obama is expected to focus on long-term fiscal discipline, while maintaining policy support for an economic recovery in the near-term as the country rebuilds after its worst recession since the Great Depression.

The two-year study by the panel, assembled by the highly respected National Research Council and the National Academy of Public Administration, said that the White House had some time on its side to restore growth, but must then act.

�In the next year or two, large deficits and more borrowing are unavoidable given the severity of the economic downturn. However, action ought to begin soon thereafter,� they said.

The national debt has risen above 50 percent of GDP (gross domestic product) from 40 percent two years ago, and within 20 years will blow past a previous record above 100 percent of GDP set after World War Two without stern official steps.

Mounting debt could sap investor confidence in the economy, and the nation�s ability to honor its obligations, pushing up interest rates and causing a steep fall in the value of the dollar as international creditors seek safer returns elsewhere.

Cut Health Care

The committee identified curbing Medicare, Medicaid and Social Security spending as the top challenge, and had a lukewarm assessment of cost containment in health care reform currently before Congress that Obama hopes to sign soon.

Committee co-chair John Palmer said the reforms might lay the foundation for improvements in the future, but he was skeptical about presumed saving levels and said that �passage would not change in any substantial way our analysis.�

The committee, which included three former heads of the CBO, outlined a range of options to lower the ratio of the national debt to 60 percent of the size of the economy.

The 60 percent threshold of debt to GDP, a target that is also used by the nations sharing the euro common currency, was a �judgment choice,� said Penner, who is a senior fellow at the Urban Institute, a Washington think-tank.

He said it was deemed to be the most that could be borne without incurring debt levels that would drive up long-term interest rates, and the least that was politically feasible in terms of reductions in government spending.

At one end of the options, the committee reviewed a policy mix based on low spending and low taxes. This envisaged payroll and income tax rates staying as they are, around 18-19 percent of GDP, but healthcare and retirement program costs sharply curtailed and defense and domestic spending cut 20 percent.

The other end of the scale looked at a high spending/high taxes policy mix that would maintain the projected growth in Social Security and allow higher spending on federal programs.

However, this would see taxes rise above 40 percent of GDP, or in the neighborhood of Denmark or Sweden, in order to hold the national debt to 60 percent, unless a value added sales tax was also introduced to augment government revenue.

Between the two were several intermediary solutions relying on a blend of higher taxes and lower spending. The committee made no recommendations but warned there was no time to waste.

�If action is taken soon, the country has a wide choice of options to help achieve fiscal sustainability. All are difficult; but if action is postponed, the options will be fewer and the choices even more difficult,� they said.