This Bloomberg Government Study finds that a significant federal deficit-reduction deal would lower interest rates in the long run and benefit the nation’s economy and various businesses by reducing their cost of capital while substantially increasing the market value of publicly traded companies.
This study, the second of four parts, quantifies in several ways a rarely acknowledged beneficial impact of a $4 trillion federal deficit-reduction package: corporations would save at least $60 billion a year in interest payments, and the value of publicly traded companies would increase by $1.1 trillion. A larger deficit deal would, of course, result in greater benefits.
The logic is straightforward: A credible budget deal would reduce the pressure on credit markets caused by federal government borrowing, which would decrease interest rates paid by the private sector as well as reduce the cost of capital for companies. While
long-term interest rates have been artificially low in the wake of the recent financial crisis,
they eventually will climb back to historic levels, with or without a deficit-reduction deal.
A credible package, however, would restrain the eventual increase in rates.
This study finds that a $4 trillion combination of spending cuts and tax increases offers
two primary benefits:
- A deal that size, which is the one most commonly discussed, will produce interest rates that would be approximately 0.5 percent, or 50 basis points, lower in the long run than if no agreement is reached. That would save companies roughly $60 billion a year in interest payments.
- A reduction in interest rates would lower companies’ cost of capital, which would eventually lift the value of publicly traded companies by about $1.1 trillion. Much or all of this impact could be realized quickly, as soon as investors believe a deal has been reached (perhaps even before it’s implemented), or the positive effects may not occur until later when investors actually observe deficit reduction occurring.
The negative impacts from a deficit-reduction plan, such as job losses spurred by fewer federal contracts or corporate tax increases, are quite tangible, especially when compared to a deal’s most oft-cited benefit, namely putting the country on sounder financial ground. These additional business benefits are somewhat conceptual and rather diffuse, and that may make it difficult for elected officials to benefit politically by taking credit for them. The next two installments in this deficit-reduction series will evaluate the direct business impacts of possible spending cuts and tax increases in a deficit-reduction agreement.
To access this complete study, as well as the next two installments, request a free trial of the Bloomberg Government information service.
Robert Litan is Bloomberg Government’s director of research. He previously worked at the Kauffman Foundation as vice president for research and policy and at the Brookings Institution as a senior fellow. During the Clinton administration, he served as deputy assistant attorney general at the Department of Justice and then as associate director of the Office of Management and Budget. Litan received a B.S. in economics from the University of Pennsylvania, a J.D. from Yale Law School, and a master’s and Ph.D. in economics from Yale University.
Tony Costello is Bloomberg Government’s lead analyst. He spent four years as a buyside investment analyst covering energy at Osprey Partners and Mooring Financial. In these positions, Costello evaluated energy-related securities and made recommendations to portfolio managers. His undergraduate degree is in finance from George Washington University and he holds an MBA from The Darden School at the University of Virginia.
Chris Payne is a senior economic analyst with Bloomberg Government. After getting his Ph.D. at the London School of Economics, he served as a research fellow at Duke University. Payne worked as a CPA at PricewaterhouseCoopers and was a vice president at JPMorgan Securities covering Asian emerging markets. He also has a master’s from the London School of Economics and a B.A. from Cambridge University.
Patrick Driessen is a taxation policy analyst for Bloomberg Government, which he joined after a career as an economist and revenue estimator at the Joint Committee on Taxation and the Treasury Department. Driessen received a Ph.D. from the University of Michigan, and specializes in international and accounting tax issues as well as the tax legislative process.