Memo To Republicans: Default Is A De Facto Tax Increase On Job Creators

July 19, 2011 12:09 pm ET

Congressional Republicans continue to insist that any deal to raise the debt ceiling and reduce the federal deficit must not include revenue increases. So steadfast and inflexible is their position that they'd rather see the economy plunge than raise taxes or eliminate subsidies. But behind the Republican Party's uncompromising position lays another reality: A higher interest rate caused by a default would increase the cost of borrowing and acquiring capital. For a small business looking to expand or hire additional workers, such an increase in interest rates has the same impact as a tax increase. But unlike the elimination of specific tax benefits proposed by the Obama administration, the de facto tax increase that would come as a result of default would have an impact directly on the small businesses that Republicans claim to be protecting. And unlike a targeted revenue increase, the higher cost imposed on businesses will not go towards reducing the deficit.

Default Threatens Our Credit Rating And Interest Rates...

U.S. Default Would Lead To Lowering Of Short-Term And Long-Term U.S. Credit Rating. According to a statement from Standard & Poor's:

Standard & Poor's still anticipates that lawmakers will raise the debt ceiling by the end of July. ... However, if the government is forced to undergo a sudden, unplanned fiscal contraction — as a result of Treasury efforts to conserve cash and avoid default absent an agreement to raise the debt ceiling — we think that the effect on consumer sentiment, market confidence, and, thus, economic growth will likely be detrimental and long-lasting. If the government misses a scheduled debt payment, we believe the effect would be even more significant and, under our criteria, would result in Standard & Poor's lowering the long-term and short-term ratings on the U.S. ... until the payment default was cured. [, 7/14/11]

Downgrading Of U.S. Credit Rating Will Increase Interest Rates. Bruce Barlett, a former Reagan administration official, explained in a Washington Post op-ed:

The bond-rating agencies have repeatedly warned that any failure to pay interest or principal on a Treasury security exactly when due could cause the U.S. credit rating to be downgraded, which would push interest rates up as investors demand higher rates to compensate for the increased risk.

J.P. Morgan recently surveyed its clients and asked how much rates would rise if there was a delay in payments, even a very brief one. Domestic investors thought they would go up by 0.37 percentage points, but foreign buyers — who own close to half the publicly held debt — predicted an increase of more than half a percentage point. Any increase in this range would raise Treasury's borrowing costs by tens of billions of dollars per year. [Washington Post, 7/7/11]

Prominent Economists Warn That Default Will Mean Higher Interest Rates For U.S. Businesses And Consumers. In June, a letter signed by some of the county's top economists, including six Nobel Laureates and five former presidents of the American Economic Association, warned Congress that not raising the debt limit would translate into higher prices for U.S. businesses and consumers:

The U.S. economy looks fragile at present. Economic growth has been too weak to generate sufficient new job creation. Reaching the limit on total outstanding debt could force a dramatic and sudden cut in federal spending that would destroy jobs and threaten the recovery. To remove spending from the economy at such a pivotal moment would be irresponsible.

Failure to increase the debt limit sufficiently to accommodate existing U.S. laws and obligations also could undermine trust in the full faith and credit of the United States government, with potentially grave long-term consequences. This loss of trust could translate into higher interest rates not only for the federal government, but also for U.S. businesses and consumers, causing all to pay higher prices for credit. Economic growth and jobs would suffer as a result. [Economic Policy Institute, 6/29/11, emphasis added]

...Which Will Increase The Cost Of Doing Business

Higher Interest Rates "Would Trickle Throughout The Economy." As Center for American Progress economist Christian E. Weller explains: "Failure to raise the debt limit would deliver a serious blow to U.S. financial markets. The stock market would plunge in a panic due to the uncertainty over the U.S. government's willingness to pay its bills and consequently what that would mean for the U.S. economy. The economy would take a serious hit. Once government borrowing resumed-as surely it must as both parties will eventually come to an agreement to run the government-lenders to the U.S. government would demand higher interest rates on U.S. treasuries. These higher interest rates would trickle throughout the economy because treasury interest rates are the benchmark against which other interest rates, such as for mortgages and business loans, are set." [Center for American Progress, May 2011, emphasis added]

World Bank: "Higher Borrowing Costs" Will Cause Businesses To "Invest Less." According to the World Bank: "Higher borrowing costs could reduce both the level and the growth of GDP. Higher capital costs due to increased long-term interest rates and less abundant capital are likely to cause firms to invest less, which will reduce the amount of capital employed in the economy and lower GDP levels from what they would have been had capital costs remained low. During the transition period from a high capital usage regime to a lower capital usage regime, the rate of growth of potential output in the economy will slow." [World Bank, June 2011, emphasis added]

Failure To Raise Debt Ceiling Will Make It Harder To Get Credit Small Business Owners Rely On. In an op-ed in USA Today, small business expert Rhonda Abrams writes: "If the debt ceiling isn't raised, and raised soon, you're going to find that it will be tougher — far tougher — to get ... any kind of credit. If you do get credit, you'll pay higher &mash; much higher — interest rates. Virtually every small business owner depends on credit. Perhaps it's using a credit card to pay for a trip to call on a potential customer. It might be getting a line of credit from a bank to buy materials to fill a big order. Or maybe you get a loan to buy equipment, vehicles, or a warehouse." [USA Today, 7/8/11]

Business Leaders Issue Warnings About A Default Crisis

Coalition Of Business Groups: "Massive Spike In Borrowing Costs" From Default Would 'Jeopardize Growth.' According to The Hill:

A coalition of some of the nation's largest business groups delivered a simple, direct message to congressional leaders: Raise the debt limit, and do it promptly.

A failure to raise the debt limit could endanger the economic recovery in a significant way, and it is "critical" America protect its reputation with investors worldwide, 60 business groups warned top leaders in the House and Senate Wednesday.

"With economic growth slowly picking up we cannot afford to jeopardize that growth with the massive spike in borrowing costs that would result if we defaulted on our obligations," the groups wrote in a letter, a copy of which was obtained by The Hill. "It is critically important that the United States stands fully behind its legal obligations."

Signers of the letter include some of the largest and most influential business groups in the nation, including the U.S. Chamber of Commerce, the Financial Services Roundtable, and the National Association of Manufacturers. The groups describe themselves as representing "a broad swath of the business community and whose members employ millions of Americans." [The Hill, 5/11/11, emphasis added]

JPMorgan Chase Executive: Default Could Raise Borrowing Rates And Damage Recovery. From a letter to Treasury Secretary Timothy Geithner by Matthew E. Zames, a managing director at JPMorgan Chase and the chairman of the Treasury Borrowing Advisory Committee, via the New York Times:

Fourth, a Treasury default could severely disrupt the $4 trillion Treasury financing market, which could sharply raise borrowing rates for some market participants and possibly lead to another acute deleveraging event. Because Treasuries have historically been viewed as the world's safest asset, they are the most widely-used collateral in the world and underpin large parts of the financing markets. A default could trigger a wave of margin calls and a widening of haircuts on collateral, which in turn could lead to deleveraging and a sharp drop in lending.

Fifth, the rise in borrowing costs and contraction of credit that would occur as a result of this deleveraging event would have damaging consequences for the still-fragile recovery of our economy. In 2008, placing the GSEs in conservatorship combined with a tightening of credit standards caused mortgage spreads to widen by 1.5 percent, ultimately raising mortgage rates for consumers. A similar rise in mortgage and Treasury rates would adversely impact economic growth, potentially pushing the U.S. economy back into recession. [Zames Letter via New York Times, 4/26/11]

U.S. Chamber Of Commerce: Failure To Raise The Debt Ceiling Would "Threaten The Credit Rating Of The United States." According to the Wall Street Journal:

The U.S. Chamber of Commerce waded into the fight over increasing the government's borrowing limit on Friday by urging members of Congress to raise the debt ceiling "as expeditiously as possible."

The business community's chief lobby in Washington made the case in a letter to lawmakers signed by Bruce Josten, the group's head of government affairs, arguing that failure to pass legislation authorizing an increase in borrowing by Aug. 4 "would create uncertainty and fear, and threaten the credit rating of the United States."

As conservative critics of raising the debt-limit grow louder and louder, the White House and Republican congressional leaders need groups like the Chamber along with small banks and businesses in members' districts, to persuade lawmakers that default would be a huge blow to credit markets, crippling the economy. [...]

In the letter, Mr. Josten says, "the current and projected level of government deficits and debt are unsustainable," arguing these debt levels will eventually lead to inflation and higher interest rates that could cripple the job market and make it more expensive for the government to borrow. [Wall Street Journal, 5/13/11]