It’s true that the fiscal cliff poses a significant threat to the economy if left completely unaddressed deep into 2013. But although the two most well-known components of the cliff (which is better described as a “fiscal obstacle course”) are the expiration of the Bush tax cuts and the sequestration cuts, neither scheduled change poses nearly as large a danger to the economy in the immediate future as a failure to raise the debt ceiling.
Last year, President Obama allowed congressional Republicans to hold the economy hostage by refusing to raise the debt ceiling until their demands to cut spending were met. Obama eventually agreed to cut roughly $2 trillion in spending, including $800 billion from the discretionary spending caps and $1.2 trillion from the sequester (which includes discretionary and some mandatory spending). This set a dangerous precedent that the minority party could use the debt ceiling to extract policy concessions from the majority.
FULL ANALYSIS FROM EPI: Budget battles in the lame duck and beyond
Appearing to recognize this dangerous precedent, the president has now proposed defusing the debt ceiling by allowing any president to raise the debt ceiling, with only a two-thirds vote in Congress able to prevent the increase. This is a positive development, as are the signs that congressional Democrats are demanding that any resolution to the fiscal cliff must also address the debt ceiling, which is projected to be reached in late December (or mid-February after the Treasury has used up all its creative accounting tricks). But it is important that, like the Obama proposal, any resolution doesn’t just raise the debt ceiling, but instead permanently reforms it, and preferably eliminates it entirely. Here are six reasons why the debt ceiling should not survive the fiscal cliff:
1) It threatens the economy. The economy will clearly suffer if the debt ceiling is ever reached. Treasury bonds are the benchmark for most other financial products, so if interest rates on Treasury bonds start rising and/or experiencing volatility, so too will mortgage rates, business loans, car loans, municipal bonds, etc. It’s not hyperbole to say that uncertainty about the bedrock of the global financial system (the safety of U.S. government debt) could lead to a financial crisis that caused damage far worse than the 2008 financial collapse.
Even if the Treasury were able to avoid officially defaulting on the debt by prioritizing interest payments, the government would have to immediately cut expenditures by roughly 10 percent of that month’s GDP, and more than that as time went on. This means Social Security checks would be cut, doctors would not be reimbursed in full for seeing Medicare and Medicaid patients, and private contractors doing business with the federal government would not be paid. All of this would constitute a massive demand shock to the economy.
Finally, even if the debt ceiling isn’t reached, simply the added uncertainty may have economic implications, possibly costing up to a percentage point of GDP and a million jobs during the last debt ceiling showdown. But let’s be clear: The damage done by reaching the debt ceiling does not have economic roots. That is, there is zero indication that there is any real economic constraint on the U.S. government’s ability to keep borrowing in coming years, as interest rates on U.S. Treasuries remain historically low. Instead, the damage done by slamming into the statutory debt ceiling is driven strictly by politics; in short, it would be a purely self-inflicted wound.
2) It weakens democratic accountability. An increase in the debt ceiling can be obstructed by either party, even a party that is in the minority. And yet, voters generally blame the president and/or party in power if the economy falters. This provides the minority party with a huge incentive to make policy demands and threaten to obstruct the debt ceiling increase if their demands are not met. It is important to protect the ability of the minority to participate in the legislative process, but the minority should not be able to bring down the entire economy if they don’t get their way.
3) It makes the deficit worse. The U.S. government enjoys low financing costs on its debt because default is so unlikely. But continuing a policy like the debt ceiling undermines confidence in the debt by allowing political gridlock and hostage-taking—both of which are increasingly common—to lead to default. The added risk could cause markets to demand higher interest rates on the $500 billion of debt that the U.S. government rolls over every month, leading to higher deficits. For example, a 10 basis-point increase in interest rates (0.1 percentage points) would cost an additional $130 billion over a decade. Again, these higher interest rates would not result from fundamental economic pressures, but simply from the arbitrary political construct that is our statutory debt ceiling.
4) It is duplicative. Congress already specifies the spending and revenue levels that determine the deficit and level of additional borrowing needed. If it wants a lower level of debt, it can make spending and revenue level adjustments to achieve that lower level.
5) It is likely unconstitutional. Reaching the debt ceiling would prevent the government from being able to continue to make its payments on existing debt, leading to a default. Yet the 14th Amendment clearly states: “The validity of the public debt of the United States, authorized by law … shall not be questioned,” leading many experts to conclude that the debt limit is unconstitutional. Furthermore, reaching the debt ceiling would require that the president unilaterally cut spending or raise taxes to stay below the debt ceiling, despite the fact that spending and revenue levels are already authorized by law. This would force the president to usurp either Congress’ power to tax or its power to spend, both of which are powers explicitly granted to Congress by the Constitution.
6) It doesn’t even measure the right debt. The debt ceiling is such poor policy that it isn’t even measuring the right thing. The ceiling caps the total debt issued by the U.S. Treasury, or “gross debt.” But 30 percent of this debt is held in government trust funds—most notably the Social Security trust fund—and another 10 percent is held by the Federal Reserve, also a government entity. This is debt that the federal government owes itself, but it doesn’t represent the indebtedness of the government—only about 60 percent of the debt that counts toward the debt ceiling actually measures the amount that the federal government is indebted to outside entities. And of this amount, nearly half is held by Americans, either private domestic investors or state and local governments. Only about $4.7 trillion—out of a total $16 trillion in gross debt—is debt held by foreign entities, i.e. debt that we don’t simply owe ourselves.
So how does it get scrapped? Given that the GOP House leadership are threatening to not raise the debt ceiling at all, it seems unlikely they’d agree to a more aggressive reform. But according to Jack Balkin, a law professor at Yale Law School, President Obama actually has a few options, even in the absence of congressional cooperation. First, the president could order the Treasury to mint $1 trillion coins and deposit them in the Federal Reserve, which would then be credited back to the federal government account, thus keeping the federal government under the debt limit. Or he could sell to the Federal Reserve an option to purchase federal property (which the Fed would not exercise), crediting the proceeds back to the federal government’s account. Finally, the president could simply state that the debt limit statute is unconstitutional because, as stated above, following it would force him to violate Congress’ constitutional power to tax and spend.
President Obama should immediately begin exploring these options (if his administration isn’t already). These options—especially the $1 trillion coins option—may seem a little ridiculous, but the debt ceiling itself is a ridiculous and manufactured problem in the first place. Given that, these solutions are actually well-suited to the problem they would address.