The Debt Ceiling is Back

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By Torus Lu

In early March, Congress received a letter from Treasury Secretary Steve Mnuchin regarding the debt ceiling.  Among the details included in the letter was the exact date on which the federal government would hit the debt ceiling – March 15.

The debt ceiling is a statutory limit on the amount of debt that can be issued by the Treasury.  While this is a constitutionally-enumerated power of Congress, there is nothing forcing Congress to pair its fiscal legislation with debt ceiling changes responsibly.  As such, Congress routinely passes fiscal legislation that causes an increase in national debt beyond the debt ceiling without actually increasing the debt ceiling.  This puts the executive branch into a difficult situation.  It is required to make all of the expenditures that Congress has authorized, but if a debt ceiling increase is not passed in a timely manner, debt cannot be issued to fund those expenditures, and the government can default on its obligations.

The U.S. government reached its debt ceiling on March 15, and since then, it has been in “extraordinary measures” mode.  Essentially, the Treasury is now making use of several accounting tricks to make sure that it does not default.  In 2013, Urban Institute economist Donald Marron detailed one such extraordinary measure involving a retirement plan for federal employees that invests in government debt:

“…the Treasury Secretary has a special power: he can replace those bonds with IOUs. I kid you not. One day the G-Fund has Treasury bonds, and the next it has IOUs. Those IOUs don’t count against the debt limit, but they will eventually be repaid with interest once the debt limit gets increased.”

In the current case, the Bipartisan Policy Center has estimated that extraordinary measures will keep the U.S. government from having to default until October or November.

This scenario where the federal government defaults is not outside the realm of possibility.  The federal government came perilously close to exhausting its extraordinary measures in 2011 and 2013.

In the event of the government defaulting on its obligations, the consequences are vague, mostly because the exact scenario has not happened before.  In 2013, there was a government shutdown, although this was due to an inability of Congress to pass funding legislation instead of a debt ceiling crisis (the debt ceiling debate happened concurrently, but was not the cause of the shutdown).  The government shutdown featured a prioritization of certain critical government functions, such as military operations.  At the same time, many important functions of government get cut.  Nearly half a million civilian workers in the Department of Defense, for example, were furloughed during the 2013 government shutdown, along with 68 percent of Centers for Disease Control employees, 70 percent of Department of Justice civilian employees, and 97 percent of National Aeronautics and Space Administration employees.  National parks closed, and a nutritional program for pregnant women and children ceased for the duration of the shutdown, along with food safety inspections by the Food and Drug Administration.

That is the optimistic scenario.  Under the government shutdown, there was no question of whether critical functions could be funded.  With a default, the Treasury is constrained to spending only the cash it has on hand or the revenue it receives at that particular time.  In 2011, a study by the Bipartisan Policy Center on the potential effect of a default that year found that funding Social Security, Medicare, Medicaid, defense contracts, debt interest, and unemployment insurance would exhaust all federal revenues.  This would leave other government activities, e.g. paying active duty military, veterans’ benefits, and tax refunds, entirely unfunded.  On an annualized basis, the immediate constraint on spending would erase ten percent of U.S. GDP.  There is little reason to think that the government today is so structurally different that a default in 2017 would have a different effect.

The debt ceiling can also result in negative consequences even if default is avoided.  In 2011, the political brinkmanship related to the debt ceiling led the Standard and Poor’s credit rating agency to downgrade the United States from AAA to AA+.  A Government Accountability Office study of the 2011 debt ceiling crisis found that $1.3 billion in borrowing costs were incurred just from having to pursue extraordinary measures, with additional increased borrowing costs in later years.  This is relatively small given the overall size of the United States government, but is also an entirely avoidable cost.  There is significant agreement (84 percent) in the University of Chicago’s IGM Economic Experts Panel that the debt ceiling creates unnecessary uncertainty and can lead to worse fiscal outcomes.  Treasury Secretary Steve Mnuchin called the debt ceiling a ‘ridiculous concept’.

A debt ceiling crisis in 2017 could be expected to have this sort of consequences.  A last-minute deal will avoid a default and government shutdown, but it will also further shake confidence in U.S. bonds, and may result in another credit downgrade.  Small but significant costs are already accumulating from Mnuchin’s extraordinary measures.

At the moment, it seems that the debt ceiling has not been raised because there are higher-priority issues, and extraordinary measures mean that the point where negative consequences occur is sometime in the future.  In past years, however, the crises occurred primarily because of partisan fights over other issues.  Democrats have been supportive of debt ceiling raises without strings attached, while Republicans have used the debt ceiling as a negotiating tool.  In 2011, some Congressional Republicans were asking for spending decreases equivalent to the amount the debt ceiling was raised.  House Minority Leader Eric Cantor wanted a Balanced Budget Amendment.  In 2013, Republicans proposed a wide variety of fiscal reforms to go with a debt ceiling raise, such as means-testing Social Security, raising the retirement age, ending agricultural subsidies, cutting Medicaid, and privatizing Medicare.  House Minority Leader Nancy Pelosi (D-California) reiterated the Democrats commitment to clean debt ceiling raises in early March

With the current debt ceiling, Senators Rob Portman (R-Ohio), Mike Lee (R-Utah), John Barrasso (R-Wyoming), and Johnny Isakson (R-Georgia) have proposed a bill to raise the debt ceiling in exchange for equivalent spending decreases across ten years, similar to the final resolution of the 2011 debt ceiling crisis.  Under the Budget Control Act of 2011, spending cuts amounting to $917 billion over ten years were made, along with a debt ceiling increase of $900 billion.  While this is by no means a perfect prediction of the final compromise, let us suppose the debt ceiling is increased in this manner.

The Congressional Budget Office projects $2.3 trillion in budget deficits from 2017 through 2020.  To increase the debt limit by this amount, $2.3 trillion in spending cuts over the next ten years would have to happen.  Indeed, Senator Portman’s website claims that $2.5 trillion in spending cuts will occur over the next decade due to this bill.

Given that Republicans hold both Congress and the White House, it seems unlikely that they would be willing to stage another controversial fight over the debt ceiling.  However, should the president’s priorities, including passing large increases in infrastructure and military spending, conflict with other Republicans’ desire for spending cuts, there may very well be another debt ceiling fight.

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