Ratings agency Standard & Poor’s has delivered a stunning vote of no confidence in US political leaders to come up with a solution for swollen budget deficits with its decision to cut its outlook on US government debt to “negative” from “stable” for the first time in history.

S&P has thrown into sharp relief the political polarisation that is crippling Washington by questioning whether the “gulf of differences” between Republicans and Democrats over how to reduce the country’s yawning budget deficit can be resolved. There was a risk, it said, that US policy makers might fail to reach agreement on how to address budgetary challenges by 2013, which would leave US government finances in worse shape than other triple-A-rated countries.

S&P’s warning rattled markets even though the problem with mounting US budget deficits, and rapidly rising US government debt, are well known. In its World Economic Outlook released earlier this month, the IMF projected that the US budget deficit would reach 10.8% this year — the largest among the advanced economies, and the US government’s gross debt would likely exceed 110% of GDP by 2016.

Indeed, it said, the US is the only large advanced economy where the government budget deficit is set to increase this year, despite the pick-up in economic activity.

Sign up for a FREE 21-day trial and get Crikey straight to your inbox

By submitting this form you are agreeing to Crikey's Terms and Conditions.

But S&P’s move — which implies a one-third chance that the US will lose its triple-A status in the next two years — forced markets to ponder the possibility that the US government debt might eventually be downgraded, which would push up US borrowing costs and could threaten the US dollar’s role as a global reserve currency.

The S&P warning comes after President Barack Obama and Republican lawmakers have released elaborate plans to slash the US budget deficit by at least $4 trillion over the next 10-12 years.

The Republican blueprint, written by House Budget Committee chairman Paul Ryan, proposes major cuts in spending on social programs and health care, particularly on Medicare, the health program for the elderly and disabled, and Medicaid, the health care programs for the poor. It also plans to cut the top individual and corporate tax rate to 25%, from 35% at present. In contrast, President Obama’s plan imposes tax increases on the wealthy, and there are only minor cost reductions in healthcare spending.

S&P saw the two proposals as a good starting point for negotiations on cutting budget deficits, but added that it saw “the path to agreement as challenging because the gap between the parties remains wide”. And it warned that negotiations between the two sides could be stalled ahead of next year’s Congressional and presidential elections.

Other analysts point out that even if the two sides manage to cobble together a decade-long deficit reduction program, it is unlikely to be fully implemented while the US economy remains weak and unemployment levels remain stubbornly high.

And a rapidly ageing population means that the deficit woes are set to become even more severe, because the US has larger unfunded commitments on social security and healthcare than most other developed countries.

*This first appeared on Business Spectator.