August 23, 2014

Fixing The Debt Limit Frankenstein

Like Frankenstein’s monster, the statutory debt limit will soon come back to life. It has been in a state of suspended animation since the October 2013 budget deal that ended the government shutdown.

The terms of that deal allowed the government to borrow without limit through this Friday, when the suspension period ends and the current debt level of about $17.3 trillion instantly becomes the new limit.

The Treasury will still be able to use  “extraordinary measures” for a while to keep its borrowing under the limit. However, as Treasury Secretary Jacob Lew explained in a recent letter to Congress, those measures will probably last for only a few weeks.

So despite hopes that the budget deal would break the chaotic cycle of fiscal crises, we’ll soon be facing another showdown unless swift action is taken.

That might not be as easy as many on Capitol Hill are assuming. Republicans generally favor adding yet-to-be determined conditions to any debt limit increase while Democrats insist that there can be no strings attached.

It might get resolved without a crisis this time, but the risk is still there and will return whenever the debt limit needs to be raised again.

If we truly want to move beyond episodic crisis management and back to rational budgeting we should recognize that the debt limit has itself become part of the problem.

Under the current system, the limit lacks any direct ties to the state of the economy or spending and tax decisions. Politicians simply pick a numbers and then fight about it, turning the congressional budget process into a series of shortsighted makeshift deals cobbled together at the last minute.

If the main purpose of the debt limit has simply become an opportunity to provoke a crisis, it would be best to scrap the current system and replace it with a more rational and effective alternative – one that provides more than a false impression of fiscal rectitude.

The problem begins with a basic misunderstanding. You might think that a “debt limit” would actually exert control over the nation’s fiscal policies. It does not.

As the Government Accountability Office explains: “The decisions that create the need to borrow are made separately from – and generally earlier than – the decisions about the debt limit.”

All the debt limit does is check the government’s ability to pay the bills that it has already run up. It’s like trying to curb your personal spending by tossing your unpaid credit card bills in the back of the closet. 

Consider that no one has proposed a serious budget plan that would prevent further increases in the current limit. Not President Obama, not the Senate, not the House.

In fact, the Fiscal 2014 spending legislation that just received bipartisan approval requires additional borrowing – it just didn’t acknowledge that explicitly.

Moreover, we don’t need a hard dollar cap on the debt. Washington’s goal should be to first stabilize the debt and then bring it down to a sustainable level relative to the economy. Even if the debt continues to grow, it will become less of a threat if it grows more slowly than the economy. 

Following World War II, for example, the debt was $242 billion and 106 percent of GDP. By 1974, the debt had grown in dollar terms to $344 billion but had shrunk to only 23 percent of GDP.

Some argue that the debt limit provides useful leverage to extract fiscal reforms that would be hard to enact otherwise. However, this is ultimately a “trigger” that can’t be pulled. Refusing to pay the nation’s bills would damage the nation’s creditworthiness and economy while doing nothing to address the underlying mismatch between federal spending and revenues that is producing higher debt.

Threatening a debt-limit breach to make demands also carries an implicit assumption that you are willing to take more risk with the nation’s creditworthiness than your political opponents. House Speaker Boehner demonstrated the limits of this strategy last year by first promising a “whale of a fight” over the limit only to concede at the last moment that there was actually no alternative to raising it.

If politicians want to add something to the debt limit that might do some good, they should create a Debt Limit Reform Commission to come up with a way to tie the nation’s debt to an economically relevant standard such as the growth rate of the economy.

Reform should also align debt limit increases with the policy decisions that require more borrowing. For example, any bill that would cause the debt to rise beyond an approved level should explicitly acknowledge this by either including a debt limit increase or offsets to prevent an increase.

In any case, the real solution to unsustainable debt is not to risk default but to enact more fiscally responsible policies in the first place.