Separating the Debt Limit from the Deficit Problem

by Kathy Ruffing and Chad Stone

Center on Budget and Policy Priorities
July 21, 2011

http://www.cbpp.org/cms/index.cfm?fa=view&id=3545

PDF of this report (7pp.)
http://www.cbpp.org/files/7-21-11bud.pdf

Policymakers are risking a default on U.S. federal
obligations because of a dispute over how to reduce budget
deficits.  The nation's long-term fiscal path is
unsustainable, and policymakers should address it in a
timely and responsible way.  But policymakers should not
hold the debt limit hostage to approval of deficit reduction
measures that satisfy various ideological or political
concerns.  Policymakers cannot let the government default.

The President and Congress set budget policy through
spending and tax legislation that is separate from the debt
limit.  Policymakers should raise the debt limit in a timely
manner to avert a default while they continue to work on a
long-term deficit reduction package.  In addition, as part
of a long-term package, they should consider eliminating the
debt limit altogether because, as the events of recent weeks
make clear, it creates opportunities for political mischief
while putting the nation's financial standing at risk.

Congress' failure to raise the debt limit in a timely manner
would leave the Treasury powerless to borrow money except to
refinance maturing securities.  With the power to spend only
what it collects in revenues, the government would have to
cut spending abruptly by over one-third, putting an enormous
drag on economic growth at a time when the economy is
struggling to recover from the Great Recession. It also
would harm millions of businesses, employees, and
beneficiaries who rely on timely federal contract,
reimbursement, benefit, or other payments.

Moreover, while some lawmakers say the Treasury Department
could prioritize expenditures to avoid problems after a
default, Treasury Secretary Geithner says the Treasury lacks
the authority to do so - and that such a step would not
reassure financial markets anyway. History shows that even
the uncertainty surrounding a debt limit increase can raise
interest rates; rates rose modestly during debt-limit
debates in 2002, 2003, and 2010 and during a brief
"technical default" in 1979 that was due to computer
glitches.  Even a temporary default would throw away the
nation's stellar credit rating and probably raise the
government's borrowing costs permanently.

Federal debt is indeed on an unsustainable path in the long
run, and policymakers need to squarely address this
challenge.  But the nation does not face an immediate debt
crisis, and the long-run fiscal challenge has nothing to do
with the debt limit.

Debt Determined by Spending and Tax Policies and the
Economy, Not by Debt Limit

Broadly speaking, the federal government borrows money when
it spends more than it collects.    Congress makes the key
decisions regarding how much government spends and how much
it collects separately from decisions over the debt limit.

The authority to spend money on defense and non-defense
discretionary programs comes through the annual
appropriations process.  The authority to pay for Social
Security, Medicare, and other entitlement programs comes
through the laws authorizing those programs, which Congress
periodically amends.  Federal tax laws - as well as economic
conditions - determine how much revenue comes in.

Before World War I, Congress generally had to approve each
separate issuance of federal debt. Since then, the limit has
evolved into an overall dollar cap on the amount of debt the
federal government can incur.  Since 1940, Congress has
enacted 91 separate increases in the statutory debt limit,
an average of one every nine months (though individual
increases lasted anywhere from three days to eight years).

On several occasions - notably in the Gramm-Rudman debates
of 1985 and the "budget summit" of 1990 - the need to raise
the debt ceiling may have galvanized policymakers to reduce
projected deficits.  But far more often, policymakers have
made decisions about raising the debt limit and reducing
deficits on entirely separate tracks. [1]

It makes little sense to have a limit on federal debt that
is divorced from the budgetary decisions that largely
determine the amount of debt incurred.  (And it makes even
less sense when the official measure of debt subject to
limit doesn't even accurately reflect the borrowing the
federal government does in private credit markets; see Box
1.)  In those circumstances, the mere existence of a
statutory debt limit can create problems; as the Financial
Times recently editorialized, "Sane governments do not cast
doubt on the pledge to honour their debts - which is why, if
reason prevailed, the debt ceiling would simply be
scrapped."[2]    A 1993 report by the Congressional Budget
Office (CBO) explained:

	Many analysts view the statutory limit on federal
	debt as archaic.  Through its regular budget
	process, the Congress already has ample opportunity
	to vote on overall revenues, outlays, and deficits
	(an opportunity that did not exist before the
	Congressional Budget and Impoundment Control Act of
	1974).  Voting separately on the debt is ineffective
	as a means of controlling deficits, because the
	decisions that necessitate borrowing are made
	elsewhere.

By the time the debt ceiling comes up for a vote, it is too
late to balk at paying the government's bills without
incurring drastic consequences.  In recent years, the debt
limit has served mainly as a vehicle for other budgetary and
unrelated legislation.[3]

===

Box 1: "Debt Subject to Limit" Not a Meaningful Measure of
Debt

The nation's "debt subject to limit" stood at nearly $14.3
trillion on June 30, 2011, just shy of the statutory limit
(as it has since May 16).  Yet most economists would say
that the federal debt was only $9.7 trillion.  Why the
discrepancy?

Economists and investors focus not on debt subject to limit
but rather on "debt held by the public," which is the amount
the government has borrowed in private credit markets to
cover its cash needs.  The "debt held by the public"
consists of promises to repay individuals and institutions,
at home and abroad, who have loaned the federal government
money to finance deficits.  Debt held by the public stood at
$9.7 trillion on June 30.

The gross federal debt - and its close cousin, debt subject
to limit - consists of debt held by the public plus debt
that one part of the federal government owes another part.
The Treasury issues special securities to Social Security,
Medicare, and other federal programs whose earmarked
revenues (such as from payroll taxes) have exceeded their
outlays (such as for Social Security benefits).  Those
Treasury special securities, which totaled $4.6 trillion at
the end of June, represent the assets of these programs'
trust funds, which help Social Security and some other
programs withstand economic downturns and the growing
pressures of an aging population.  As CBO points out, "those
securities represent internal transactions of the government
and thus have no direct effect on credit markets."

The fact that trust fund holdings count as part of debt
subject to limit has some perverse implications.  Between
1998 and 2001, for example, debt subject to limit continued
to grow - even as the country ran budget surpluses and
retired a large amount of debt held by the public - because
Social Security was also running large surpluses and lending
them to the Treasury.  Similarly, in Chairman Ryan's House-
passed budget resolution, debt held by the public grows by
about $6 trillion over the 2012-2021 period, but debt
subject to limit grows by about $8 trillion.  Acknowledging
this longstanding confusion, the President's Commission on
Budget Concepts in 1967 urged legislators to revise the
statutory debt limit to count only debt held by the public,
a recommendation that Congress has never addressed.

Debt held by the public is a much more appropriate measure
of federal debt, and a stable debt-to-GDP ratio is a key
test of fiscal sustainability.a    Increases in the dollar
amount of debt are not a significant concern as long as the
economy is growing at least as fast.  Between 1946 and 1974,
for example, debt held by the public grew significantly in
dollar terms but - thanks to economic growth - plummeted as
a share of GDP, from 109 percent to 24 percent.

Confusion about gross debt crops up in a widely cited
analysis of 44 countries by University of Maryland professor
Carmen M. Reinhart and Harvard professor Kenneth Rogoff,
which concluded that debt-to-GDP ratios of 90 percent or
more are associated with significantly slower economic
growth.  Their analysis, which used gross debt as its debt
measure, suggested that the United States is dangerously
close to that 90 percent tipping point.  However, what other
countries call gross debt is very similar to what we call
debt held by the public, and debt held by the public is
still well below 90 percent of GDP.  CBPP estimates that
debt held by the public will be 69 percent of GDP in 2011
and will reach 95 percent of GDP by 2021 under current
policies.  It would be 73 percent of GDP in 2021 if we let
all of the Bush tax cuts expire on schedule at the end of
2012.b

	a Ideally, as both the Office of Management and
	Budget and the Congressional Budget Office have
	noted, we 'd focus on the amount of debt held by the
	public minus net financial assets held by the
	government (such as securities and loans).  That
	measure, however, is not as readily available.

	b James R. Horney, Kathy A. Ruffing, and Paul N. Van
	de Water, "Fiscal Commission Should Not Focus on
	Gross Debt," Center on Budget and Policy Priorities,
	June 21, 2010; Kathy Ruffing and James Horney,
	"Economic Downturn and Bush Policies Continue to
	Drive Large Projected Deficits," CBPP, May 10, 2011.

===

In short, the amount of debt outstanding reflects Congress's
tax and spending decisions and the state of the economy, not
the level of the debt ceiling.  Citizens who urge their
members to vote against raising the debt limit as a way of
expressing displeasure with federal borrowing are picking
the wrong target.

Debt Ceiling Has Become Political Football

Because policymakers have long regarded defaulting on the
country's obligations as unthinkable, raising the debt
ceiling is the quintessential "must-pass" legislation.  The
onus for passing it has traditionally fallen on the party in
power.[4]

The strange practice of voting on the debt ceiling
independently of the measures that determine federal program
costs and revenues essentially makes a "no" vote costless.
The large deficits that fueled today's debt - and that are
projected to continue for the next decade -  result
primarily from the economic downturn, from the tax cuts
enacted during the George W. Bush administration, and from
fighting two wars on borrowed money.[5]  Yet some members
who supported those policies see no hypocrisy in voting
against the resulting debt.

Many Republican members of Congress oppose raising the debt
ceiling; some publicly claim they are willing to trigger a
default - which, according to the Treasury, will happen on
August 2 or soon thereafter.[6]  But influential Republicans
in the past have recognized that such brinksmanship is
illogical and irresponsible.  (See Box 2.)

Failure to Raise Debt Ceiling Would Have Shattering
Consequences

If Congress refuses to raise the debt ceiling in a timely
manner, the Treasury will be unable to borrow money except
to refinance maturing securities.  That means it could pay
out only as much as it collects in revenues - in essence,
immediately balancing the budget (and not just over the
course of a fiscal year, but from one day to the next).

The severe downturn from which the economy is only slowly
recovering continues to depress federal revenues and swell
federal outlays.  For fiscal year 2011, which ends on
September 30, revenues will cover about two-thirds of
federal expenditures, according to CBO:  the federal
government is expected to spend $3.6 trillion and take in
$2.2 trillion, necessitating borrowing of about $1.4
trillion (about 9 percent of gross domestic product) to
finance the shortfall.  If the federal government could no
longer borrow, it would have to cut spending abruptly by
over one-third - which would be economically disastrous if
it continued for any length of time.  Such cuts would put a
drag on economic growth equal to 9 percent of GDP at an
annual rate, in an economy that so far this year is growing
at less than a 2 percent annual rate.  The economy would
start shrinking, and unemployment would shoot up.

===

Box 2: Past Republican Statements on the Debt Limit

"This country now possesses the strongest credit in the
world.  The full consequences of a default - or even the
serious prospect of default - by the United States are
impossible to predict and awesome to contemplate."  -
President Ronald Reagan, 1983

"As we fight for freedom, we must not imperil the full faith
and credit of the United States Government and the soundness
and strength of the American economy." - President George W.
Bush, 2002

 "[O]ur government now needs to keep its promise to the
 American people, to all of various entitlement programs,
 but maybe most especially the program [Social Security]
 that that elderly woman asked about this morning.  We must
 raise the statutory debt limit." - Rep. Mike Pence (R-IN),
 2002

"Raising the debt limit is about meeting the obligations we
have already incurred.  We must meet our obligations.  Vote
for this bill." - Sen. Chuck Grassley (R-IA), 2006

===

Moreover, federal cash flows are both seasonal and lumpy,
and August, when the Treasury will run out of options, has
no major tax deadlines and is therefore an especially
challenging month.  The Bipartisan Policy Center (BPC)
estimates that between August 3 and August 31, a prolonged
inability to borrow would force the federal government to
cut expenditures by 44 percent.[7]   That would affect
federal employees, defense contractors, hospitals and
doctors, state and local governments, farmers, colleges and
universities, program beneficiaries, and millions of others.
All of these people and organizations rely on timely federal
payments to meet their own bills and payrolls, and an
interruption would set off a domino effect of lower demand
and missed payments throughout the U.S. economy.

In the event of a hiatus in federal borrowing, Senator Pat
Toomey (R-PA) has called for the Treasury to prioritize
certain federal expenditures, treating the payment of
principal and interest as paramount.  But as Treasury
Secretary Geithner has explained, the Treasury lacks legal
authority to do this; nor would financial markets be
reassured if they saw a cash-strapped superpower picking
which bills it could afford to pay today.  Furthermore, the
BPC calculations show that if the Treasury followed this
approach and hoarded enough cash to pay interest during
August, the cuts in other programs that month would approach
50 percent.

Even on past occasions where Congress has averted an
imminent default by raising the debt ceiling, uncertainty
about the timing of the increase has taken a toll.  The
Government Accountability Office (GAO) found that interest
rates rose modestly during the debt-ceiling debates of 2002,
2003, and 2010, though none of those episodes triggered an
actual default.[8]  Also, researchers found spikes in
interest rates during a brief "technical default" in April-
May 1979, when computer glitches prevented the Treasury from
paying certain individual investors on time.[9]  Mark Zandi,
chief economist of Moody's, predicts that markets will
become turbulent in late July if the current impasse
continues.[10]  As a large borrower, the United States can
ill afford to pay higher interest rates than necessary.  A
sustained rise of just one basis point (i.e., one-hundredth
of a percentage point) on our $10 trillion in debt held by
the public would cost $1 billion a year.

Recent Analogies to Households or to Other Countries Are
Misplaced

Some policymakers and pundits have compared the debt ceiling
to the limit on a household's credit card debt or on its
overdraft protection.  Others have likened the United States
to distressed borrowers such as Greece.  Both analogies are
seriously flawed.

Borrowers get in trouble when lenders cut off the supply of
credit.  Households have to retrench when a bank cuts their
credit-card limit because it doubts their ability to pay.
Likewise, Greece and other overly indebted countries find
themselves unable to borrow except at punitive interest
rates.  In contrast, investors both here and abroad continue
to view U.S. securities as the safest in the world.  Their
strong demand for U.S. securities is a key reason why
interest rates are so low.

To be sure, the United States needs to take significant
steps to put long-term deficits and debt on a sustainable
path.  If it does not, lenders may eventually stop regarding
the United States as a triple-A borrower.  But they will
reach that judgment very quickly if the United States
capriciously decides to stop paying its bills, which is what
will happen if Congress refuses to raise the debt limit.

While the United States faces future budget challenges
stemming from a graying population and rising health-care
costs, it also has one of the lowest ratios of federal tax
revenues to GDP among developed countries.  So it can - and
should - raise revenues as part of any package to stabilize
long-term deficits and debt.

Conclusion

As Federal Reserve Chairman Ben Bernanke stated recently,
"our nation's fiscal problems are inherently long-term in
nature" and we risk undercutting the still-fragile recovery
if we undertake "a sharp fiscal consolidation focused on the
very near term."[11]  Currently, interest rates are low, and
the United States can borrow money on very favorable terms.
But Congress risks creating an unnecessary crisis by shaking
financial markets' faith that the United States will pay its
bills on time.  And Congress risks creating a double-dip
recession if some members will vote for a debt-limit
increase only in conjunction with sharp, immediate budget
cuts.

As CBPP and others have argued, a sound goal for long-run
fiscal policy would aim to stabilize debt held by the public
as a share of GDP.  That translates into annual federal
deficits of no more than about 3 percent of GDP.  But
because the debt would still rise in dollar terms under this
scenario (though no faster than GDP), policymakers would
still have to approve periodic increases in the debt
ceiling.  That invites a repeat of this summer's
brinksmanship.  Instead, it's time to jettison the useless
debates over raising the government's borrowing limit and
get down to the serious business of setting responsible
revenue and spending policies for the long run.

End Notes:

[1] In fact, under the "Gephardt rule" that used to prevail
in the House, the House raised the debt ceiling
automatically each time it approved a budget resolution.
The House repealed that rule at the beginning of the current
Congress.  The Senate has never had a similar rule.

[2] May 8, 2011.

[3] Congressional Budget Office, Federal Debt and Interest
Costs, May 1993, p. 43.

[4] Donald Marron, "Handicapping the Debt Limit Debate,"
January 14, 2011,
http://dmarron.com/2011/01/14/handicapping-the-debt-limit-debate/ .

[5] Kathy A. Ruffing and James R. Horney, "Economic Downturn
and Bush Policies Continue to Drive Large Projected
Deficits," Center on Budget and Policy Priorities, May 10,
2011.

[6] http://www.treasury.gov/initiatives/Pages/debtlimit.aspx

[7]Bipartisan Policy Center, "Debt Limit Analysis," July
2011,
http://www.bipartisanpolicy.org/sites/default/files/Debt%20Ceiling%20Analysis%20report.pdf.

[8] Government Accountability Office, Debt Limit:  Delays
Create Debt Management Challenges and Increase Uncertainty
in the Treasury Market, February 2011.

[9] Terry Zivney and Richard Marcus, cited in Donald Marron,
"The day the US defaulted on treasury bills," Christian
Science Monitor, May 26, 2011,
http://www.csmonitor.com/Business/Donald-Marron/2011/0526/The-day-the-US-defaulted-on-treasury-bills.

[10] Damien Paletta, "Zandi: Markets Will Become Turbulent
in July If Debt Ceiling isn't Raised," Wall Street Journal
"Washington Wire," June 28, 2011,
http://blogs.wsj.com/washwire/2011/06/28/zandi-markets-will-become-turbulent-in-july-if-debt-ceiling-isnt-raised/.

[11]
http://www.federalreserve.gov/newsevents/speech/bernanke20110607a.htm


[Kathy Ruffing is a Senior Fellow at the Center on Budget
and Policy Priorities, specializing in federal budget
issues.

Ruffing spent 25 years at the Congressional Budget Office,
where she analyzed a wide range of topics including interest
costs and federal debt, federal pay, immigration, and Social
Security.  Upon her departure, the Congressional Record
praised her as a dedicated public servant who worked
tirelessly to advance the legislative process and whose
analyses displayed the best characteristics of CBO reports:
impartiality, clarity, and comprehensiveness.

Before joining CBO, Ruffing spent several years at the
Department of Labor and the Social Security Administration.
More recently, she helped launch a budget study at the
National Academy of Sciences.

Ruffing earned a B.A. in economics and political science at
the University of Pittsburgh, and an M.A. in economics at
George Washington University.

Chad Stone is Chief Economist at the Center on Budget and
Policy Priorities, where he specializes in the economic
analysis of budget and policy issues.

He was the acting executive director of the Joint Economic
Committee of the Congress in 2007 and before that staff
director and chief economist for the Democratic staff of the
committee from 2002 to 2006. He was chief economist for the
Senate Budget Committee in 2001-02 and a senior economist
and then chief economist at the President's Council of
Economic Advisers from 1996 to 2001.

Stone has been a senior researcher at the Urban Institute
and taught for several years at Swarthmore College. His
other congressional experience includes two previous stints
with the Joint Economic Committee and a year as chief
economist at the House Science Committee. He has also worked
at the Federal Trade Commission, the Federal Communications
Commission, and the Office of Management and Budget. Stone
is co-author, with Isabel Sawhill, of Economic Policy in the
Reagan Years. He holds a B.A. from Swarthmore College and a
Ph.D. in economics from Yale University.]

___________________________________________

Portside aims to provide material of interest to people
on the left that will help them to interpret the world
and to change it.

Submit via email: [log in to unmask]

Submit via the Web: http://portside.org/submittous3

Frequently asked questions: http://portside.org/faq

Sub/Unsub: http://portside.org/subscribe-and-unsubscribe

Search Portside archives: http://portside.org/archive

Contribute to Portside: https://portside.org/donate