Look Before Leaping off the Debt Limit Cliff

Author: Bob Bixby
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This week the United States bumped up against its $31.4 trillion statutory debt limit. Some on Capitol Hill believe that the need to raise the debt limit provides strong leverage to extract deep spending cuts and halt the unsustainable growth of trillion dollar deficits. The idea is simple: No spending cuts, no debt limit increase. 

Unfortunately, it’s the sort of idea that sounds great when you’re sitting around a bar with your buddies at 2 a.m. but leaves you wondering in the sobering light of day, “What were we thinking?” It’s more likely to result in a dangerous showdown over the nation’s creditworthiness than it is to control the unsustainable growth of debt. 

To be sure, there are ample reasons to be concerned about the nation’s fiscal path. Our aging population means that mandatory benefit payments for retirement and health care programs, like Social Security and Medicare, are projected to grow faster than revenues, driving deficits larger each year far into the future. Population aging will also have a dampening effect on the economy as the workforce grows more slowly. 

Debt held by the public is already approaching record levels and is projected to nearly double in the next 30 years. Over that time, interest costs on the debt are projected to become the fastest growing category of the budget. 

All of which does not account for potential negative shocks such as another pandemic, climate change, or national security threats. So yes, fiscal concerns are real.

Threatening not to raise the debt limit, however, is a reckless way of dealing with the problem because making good on the threat means having the Treasury default on at least a portion of its obligations, placing the full faith and credit of the United States at risk. That is something that should never happen.

Despite hitting the limit, the Treasury Department is still able to use “extraordinary measures” to keep borrowing under the limit and continue paying all the bills. But in a statement issued on Friday, January 13, Treasury Secretary Janet Yellen warned that these measures, plus available cash, are likely to run out sometime in June. 

It thus seems likely that at some point this summer, the government won’t be able to pay its bills because it won’t be able to issue new debt, and Congress won’t be able to do anything about it because they won’t have the votes to raise or suspend the limit. 

What happens then? Nobody knows for sure, but the available options are all bad.

One thing is certain. The government would not be able to pay all of its bills on time. Uncle Sam would become the world’s biggest deadbeat. It is impossible to reconcile this with the notion of fiscal responsibility. Think of it this way: suppose a person owes you money and they send you a note that says, “Hi there, in the interest of being fiscally responsible, I’m not going to pay you.” There are many ways you might describe such behavior but “fiscal responsibility” would not be among them.

Of course, not everyone would be stiffed at once. The government could pay some of its bills on time because revenues would still be coming in. But with annual revenues running about a trillion dollars short, many bills would go unpaid. Keep in mind that these unpaid bills would be for benefits, services, salaries and the like that are currently due; approved and enacted years ago. Nothing about this woeful exercise would eliminate the legal obligation to eventually pay the bills we’ve already incurred. We would just need to add the stigma of being a deadbeat government to the fiscal problems we already have. 

Who gets paid and who wouldn’t is very much an open question. There is no prescribed “prioritization” of federal bills because such a thing should never be needed. For decades, people all over the world have wanted to purchase U.S. securities because they are considered a safe investment. This allows the U.S. government to raise money by selling securities at relatively low interest rates. Investors don’t have to worry about getting paid in full and on time. Putting that assumption at risk, even by threatening to  stop making full payments, would damage the smooth functioning of worldwide credit markets and raise the cost of borrowing for the U.S. and its citizens.

Well then, some argue, why not just guarantee that bondholders get paid first? No doubt the Treasury would work to make sure that happened, but it is hard to believe that bondholders would be comforted by the fact that the government was having to pay some bills and not pay others. That is what happens in a Chapter 11 bankruptcy. Does anyone think that investors would take no notice?

But for the sake of argument let’s assume that a priority list is developed and that it includes interest on the debt, Social Security, Medicare, and veterans benefits –  all of which would be politically toxic to try cutting just for the sake of freezing the debt limit. Even without exempting any of these priorities, the cuts needed to get by without raising the debt limit would be about 17 percent of all spending. Cuts of that magnitude would create major chaos and economic disruption. If, however, the above priorities were protected from cuts the rest of the  budget would need to be cut by about one-third. That’s things like Medicaid, military salaries, infrastructure programs, food assistance, law enforcement, border protection…on and on https://edaslav.com/.

Before taking this leap into the abyss, it would be best to take a hard look at what could happen and perhaps come up with a better approach to putting the budget on a sound fiscal path.

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