S&P’s $2 Trillion Error
In the final hours before Friday’s historic downgrade, Standard & Poors gave Treasury an advance copy of its report. Amazingly, that report contained a $2 trillion error in its calculations of U.S. deficits and debt over the next decade. Here are four things you should know about it.
1. Treasury hoped that S&P would change its decision in light of the error, but S&P shrugged it off as not material.
In a blog post, Acting Assistant Secretary for Economic Policy John Bellows described what happened when the error was discovered:
After Treasury pointed out this error – a basic math error of significant consequence – S&P still chose to proceed with their flawed judgment by simply changing their principal rationale for their credit rating decision from an economic one to a political one.
The primary focus [of our analysis] remained on the current level of debt, the trajectory of debt as a share of the economy, and the lack of apparent willingness of elected officials as a group to deal with the U.S. medium term fiscal outlook. None of these key factors was meaningfully affected by the assumption revisions to the assumed growth of discretionary outlays and thus had no impact on the rating decision.
2. Despite S&P’s claim, $2 trillion would “meaningfully affect” “the trajectory of debt as a share of the economy.”
It’s own revised calculations show net general government debt hitting 85% of gross domestic product in 2021 instead of 93%. That’s a big difference.
The 85% figure is still uncomfortably high and may well not deserve a AAA rating. But S&P was too dismissive in its clarification.
3. The error is understandable but remarkably sloppy for such an important analysis.
The source of the error is painfully familiar to anyone who deals with U.S. budget projections. S&P’s analysts didn’t use the right measuring stick — i.e., the right budget baseline — when analyzing the effects of the recently-enacted Budget Control Act.
In one sense, it’s easy to see how this error happened. Budget discussions are now hopelessly confused by a profusion of different baseline projections of what spending and revenues will look like in the future. Indeed, I have devoted multiple posts to clarifying how different revenue baselines fit together (e.g., here and here). I’ve even used Johnny Depp to highlight the challenge.
A similar challenge exists with discretionary spending. Official budget baselines assume that annual appropriations (the defense and non-defense spending Congress fights over every year) grow with inflation unless subject to an explicit cap. That was the basis, for example, for the official baseline that the Congressional Budget Office used in evaluating the impacts of the Budget Control Act.
Before the BCA, there were no discretionary spending caps, so annual budget authority was assumed to grow with inflation from the most recent appropriated levels. The BCA then generated $917 billion in budget savings by setting annual spending caps below those levels.
S&P messed up because it based its analysis on another baseline. That “alternative fiscal scenario” assumes that discretionary spending grows at the same pace as the overall economy, not just with inflation. That baseline implies much more spending and debt over the next decade — $2 trillion more, in fact — than the official baseline.
So, again, it’s easy to see mechanically how this error happened. But it’s still remarkably sloppy. Budget experts are well-aware of the problem of multiple baselines. Indeed, we all pepper our conversations and analysis with the question “what baseline are you using?” It’s stunning that S&P didn’t have multiple analysts asking the same question to make sure their original numbers were right.
4. S&P’s response to the error further demonstrates that its primary concern about the United States is political not numerical.
As S&P said in Friday’s report:
Our opinion is that elected officials remain wary of tackling the structural issues required to effectively address the rising U.S. public debt burden in a manner consistent with a ‘AAA’ rating and with ‘AAA’ rated sovereign peers. In our view, the difficulty in framing a consensus on fiscal policy weakens the government’s ability to manage public finances and diverts attention from the debate over how to achieve more balanced and dynamic economic growth in an era of fiscal stringency and private-sector deleveraging.
In short, S&P worries that America won’t get its act together in time.