Congress Warned of Credit 'Downgrade' if War Savings Counted as Deficit Reduction

Senate Democrats' inclusion in their proposed debt package of $1 trillion in savings from the wars in Iraq and Afghanistan may not satisfy ratings agencies threatening a credit downgrade since the wars were expected to end with or without a debt deal.

The budget gimmick is one that has been used by both parties. President Obama and House Speaker John Boehner had earlier considered employing it during discussions that have since broken down. Now Senate Democratic Leader Harry Reid is using the trick in his $2.7 trillion deficit-reduction plan, according to aides. Boehner has not indicated where he would draw his savings, totaling up to $3 trillion.

To put the numbers in perspective, the Congressional Budget Office estimated earlier this year that U.S. budget deficits would total $7 trillion over the coming decade.

But to reach $1 trillion in war costs, budget scorekeepers simply look at current funding for the wars and spread that out over 10 years, rather than projecting what is going to happen in the future.

"The way the CBO constructs the baseline is it extrapolates current law, and the current law is that we are funding the wars in Iraq and Afghanistan," former CBO Director Douglas Holtz-Eakin told "The trouble is that CBO's baseline is not what anyone really thinks will happen."

More On This...

Holtz-Eakin said that while Reid's proposal is transparent about including war savings, the problem with employing it here is that ratings agencies want to see "real savings" out of the current talks.

"I don't think it'll be compelling to markets or ratings agencies," he said. "Since this spending was going to go away anyway, it would not constitute an improvement. And they want improvements."

A new memo from Goldman Sachs also suggests Congress could end up imperiling the U.S. credit rating by counting war savings.

The memo, provided to Fox News by a GOP aide, said that if the Senate plan and its supposed war savings passes without a follow-up process, "a ratings downgrade could ensue."

The separate proposals being crafted by Democrats and Republicans both fall short of the $4 trillion in deficit-reduction leading ratings agencies have urged Washington to achieve over the next decade.

But, without getting into detail, Boehner said Monday that Reid's plan is "full of gimmicks."

Nearly half of the deficit reduction in Reid's plan would come from phantom war savings, according to the Goldman memo.

"The (withdrawal of troops from Iraq and Afghanistan) would show up in official budget estimates as savings of about $1.2 trillion versus current law," the memo reads. "If this proposal were to prevail without a credible follow-on process, a ratings downgrade could ensue, since against most outside baseline budget estimates only the first portion of spending cuts, and not the war spending savings, would show up as deficit reduction."

The first portion was estimated to be worth just $1.5 trillion.

"That would leave the fiscal consolidation far short of the ~$4 trillion S&P has said it is looking for, with no catalyst for additional deficit reduction before 2013," Goldman warned.

A representative for Standard & Poor's did not return a request for comment.

Barring a new agreement, U.S. forces are scheduled to withdraw from Iraq by the end of 2011. Obama wants to end the combat mission in Afghanistan by 2014.

This will eliminate a huge chunk of war spending from the U.S. budget, but it was already anticipated. In addition, while the wars in Iraq and Afghanistan have cost in excess of $1 trillion over the last decade, several other factors were also at play in driving up the deficit during the Obama administration.

The budget deficit went from $161 billion in 2007 under George W. Bush to more than $450 billion in 2008, before soaring to a projected $1.5 trillion this year under Obama. Both presidents dealt with war costs, but budget tables show that as tax revenues fell, discretionary and entitlement spending rose significantly over the past few years. Mandatory spending rose by nearly $500 billion between 2007 and 2010. Federal spending as a percentage of GDP rose from 19.6 percent in 2007 to 23.8 percent in 2010.

Meanwhile, Democrats and Republicans remain at odds on how to raise the $14.3 trillion debt ceiling while giving the ratings agencies confidence that the U.S. is addressing its massive deficit.

While Reid is looking to take care of both issues in one package, Boehner wants to break it up into two sets of votes. His plan would authorize a short-term debt-ceiling hike now along with spending cuts worth slightly more, with another debt-ceiling vote next year after a new commission identifies further deficit reduction.

The White House argues that putting off another debt-ceiling vote until next year "could put our credit rating at risk and leave the cloud of uncertainty over the American people."

Fox News' Trish Turner contributed to this report.