As of the writing of this column, July 24, no deal has been finalized to extend the debt ceiling, which will expire next week. While there have been comments of an impending disaster, if a deal is not arranged, the likelihood of a calamity occurring is remote. Since 1960, the debt ceiling has been extended 91 times, so it is not as if Congress and the president are dealing with something unique.
First, in all likelihood, the debt ceiling will be raised. The federal government is currently running a deficit of about $100 billion per month. To think that by not raising the debt ceiling that spending and revenues will come into balance overnight is ludicrous. Clearly, our current budget deficit is excessive but it will take many years to bring it down to a reasonable level.
There are two components to the deficit – one is cyclical and the other is structural. The cyclical aspect has been caused by the recent severe recession and the subsequent slow recovery. Because employment levels are depressed, less tax revenue is being raised and government spending has increased to fund greater expenditures on programs, such as food stamps and unemployment compensation. The structural aspect of the deficit, which would occur even if the economy was near normal levels, is being caused primarily by increased government spending on healthcare.
An area that has recently been mentioned in the deficit discussions is a revamping of the tax code. One proposal actually mentioned lowering both personal and business tax rates but curtailing numerous deductions. If enacted, this would be a major boon for the economy, as substantial resources are currently wasted conforming to our very complex tax code. Of course, those industries that benefit from our tax code system would engage in a major fight to preserve their benefits.
On the expenditure side, there are reports that trillions of dollars in “cuts” need to be made. How the government defines a cut is different than how most individuals look at reducing spending. A cut in government terminology normally means spending money at a lower rate, but not necessarily have spending go down. Certainly, sacrifices will need to be made in a number of areas.
Given that the 10-year Treasury is still yielding near 3%, financial markets are not expecting a major problem, such as in Europe, where a number of countries have seen their borrowing costs escalate. The stock market is trading near its highs for the year, which also implies the debt ceiling should not pose a major problem for the economy. In essence, a short-term fix will likely occur and a crisis will be averted. A more meaningful longer-term solution would be very positive for the stock market if it comes with a simplified tax code.
