Viewpoint: In the United States, the Republican fiscal plan highlights the risks for 2013

In the debate over the risks weighing on the euro area, the hitches along Spain’s path towards fiscal consolidation have eclipsed Portugal….

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However, in recent weeks the government and creditors frontally tackled the doubts of investors over the programme, albeit without achieving much. In the United States, the Republican fiscal plan highlights the risks for 2013.
– Clumsy management of the new Spanish government’s fiscal announcements has understandably eclipsed the debate over the situation of Portugal, which by all means poses a smaller risk from a systemic point of view. However, some developments over recent weeks deserve to be commented, as they raise the stakes. The first is the determination with which international creditors and the Portuguese government are assuring that the programmes objectives for 2012 will be met without additional austerity measures. This emerged for the first time at the end of February, in the statement which followed the third review, which said that the 2012 deficit target “is expected to be met with current policies, provided that downside risks to the economic outlook do not materialize.” What’s more, debt estimates have been revised downwards, bringing down the expected peak in 2013 from 118% to 115% of GDP. Subsequently, in addition to repeatedly stressing the same point, the Minister of Finance Gaspar assured that the country will not request either additional financial aid, or a dilution of the targets laid out. Admittedly, we found such assuredness surprising, as we believed that the strong contribution made to the correction of the deficit in 2011 by one-off measures would result in additional austerity measures being required this year.
– At this point, it is of the utmost importance that the targets effectively be met. Not because otherwise a restructuring of Portuguese debt would be on the cards. Anyone envisaging a PSI deal on Portugal’s debt will be bitterly disappointed: the likeliest alternative scenario, in light of the evolution of the Greek crisis, is that the euro area will step up aid and extend its duration, possibly by activating the new instrument represented by credit facilities available to support the primary market. The cost of promises not being kept would be of that of once more undermining the credibility of the analysis produced by the European Commission and the IMF, already compromised by the Greek crisis, as well as the credibility (an even worse prospect) of the new Portuguese government, which has done well so far both on the fronts of structural reforms and privatisations. The publication of the report on the programme by international lenders should soon provide a more solid basis on which to assess the robustness of fiscal consolidation promises.
– In the United States, the Chairman of the House Budget Committee, P. Ryan, unveiled the Republican long-term budget plan. The plan lays out the guidelines for the main budget items, with targets over 10-year intervals, without specifying many details. The deficit would amount to 1.25% of GDP up to 2030, and widen to 3% in 2050. The plan has two main pillars: 1) revenues stabilise at 19% indefinitely; 2) spending stabilises at 20.25% until 2030, and then drop further. As regards revenues, the plan provides for a tax reform that would introduce only two income tax rates (20 and 25%). On this front, revenues are basically in line with those included in a scenario based on current policies. The real “revolution” concerns welfare and discretionary spending. Social security is unchanged, and the Republican scenario is in line with those drawn up by the CBO and the Democrats, Medicare spending is only modestly lower than in the other scenarios (by around 0.25-0.5% of GDP). On all other categories, spending is slashed: primary expenditure in 2023 is projected at 17.5% of GDP, compared to 20.5% in the constant legislation scenario, and 21% assuming constant policies.
Subsequently, the spread widens further. The model is clear: “Small Government” (while safeguarding senior citizens). Given this Republican platform, a scenario of bitter confrontation and cross-vetoing following the elections is almost certain. By the autumn, the debt ceiling should be binding again. Also, lacking decisions by Congress, current legislation provides for restrictive measures worth over 500 billion dollars coming into force in 2013, including tax break expirations, the introduction of new taxes, and automatic spending cuts.
The scenario for 2013 is likely to be a nightmare.


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