Measures to Cut Budget Deficit Are All on the Table

Last Updated Apr 27, 2010 12:47 PM EDT

President Barack Obama's bipartisan fiscal commission, charged with finding $250 billion in tax hikes and spending cuts in order to reduce the deficit by 2015, had its first working session today. But it was mostly on the order of making sure they had clean notebooks and sharp pencils (and knives?). The theory behind the commission is this: Both parties will hold hands and tackle these politically unpopular decisions together in what the top Republican member, Sen. Alan Simpson (Wyoming) called "a suicide mission." Republicans will take some tax hikes and Dems will eat program cuts. But right now, in a particularly partisan Congressional election year, neither side seems to have any willingness to jump off cliffs or even to hold hands.

No matter. The group's report isn't due until December, which is after the mid-term elections, and next year could be a more promising one for the tough votes that would be required to at least 'bend the curve' on federal borrowing. And that curve surely needs to be bent. The deficit was $1.4 trillion in 2009; the Federal government owes $12.9 trillion now and is expected to add another $1 trillion to that figure every year for at least the next 10 years, according to the Congressional Budget Office. The interest alone on all that debt would eventually comprise 4.5 percent of the economy and 20 percent of the Federal budget.

That's a national threat. The U.S. could end up beholden to an international cadre of bond buyers, led by China, who would require ever higher interest rates to keep holding those Treasuries. Or the U.S. government could try to print more money to pay off all of its loans in worthless dollars. Money wheelbarrows, anyone?

But it's also a personal threat. Here's what to watch for in Washington, and how it might hit your own pocketbook.

  • Taxes will have to go up. Without any legislative activity, the Bush tax cuts will expire at the end of this year, and neither party wants that to happen. They won't have to actually vote until next year, but vote on taxes they will. Most likely scenario involves a compromise in which cuts are preserved at lower income levels and only partially preserved at higher levels. Slightly higher rates on capital gains and dividends are likely in the offing after this year.
  • Caution: Steep yield curve ahead. Pessimism about the deficit is already raising yields on Treasury bonds. Meanwhile, the Fed continues to hold short term rates low. So be careful about going long because you might get caught by further rising rates as economic recovery kicks in. And those rising rates will feed on themselves. Retirees and others who depend on long-term bond interest for everyday spending might consider individual bonds that they hold to maturity. That way if yields rise, dropping bond values, they won't have to take losses, as they might in a bond mutual fund. And long-term bond holders should spread out the maturities of their holdings, so they can cash some in and buy more (at presumably higher yields) down the road.
  • Consumption taxes may appear. Nothing is off the table, as the commission members like to say. Some are floating a Value Added Tax, which would be a tax on items you buy instead of money that you make. That would be a radical change in U.S. policy. But desperate legislators might decide to tax some consumption selectively: salty foods, fatty foods, sodas, plastic bags, or, um... purchases made over the Internet? Everything is on the table.
  • Social Security is here to stay, sort of. Washington will not kill Social Security, or 'privatize' it, or radically change it for anyone within 5 years of collecting benefits. (You read it here first, or last.) But tinker? Most probably. Expect some tightening of early retirement benefits and closing of tricky loopholes that allow married couples to maximize their take by starting and stopping benefits. A later retirement age down the road? That's also definitely on that large and growing table.
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