Raise the Roof

A few weeks ago, the White House expressed regret for then-Senator Obama’s vote against increasing the level of the federal debt limit in 2006. Its remorse is well placed. Treasury Secretary Timothy F. Geithner has warned Congress that it must raise the debt ceiling, a statutory limit on the amount of money the Treasury can borrow, from its current $14.3 trillion by mid-May to early July to prevent the government from defaulting on its debt payments. By threatening to forego a needed increase in the debt limit, Republicans, like Democrats during the Bush administration, are effectively holding the economy hostage to get what they want. Congress would do well to put an end to this kind of brinkmanship by eliminating the debt ceiling altogether.

The modern debt ceiling arose on the eve of World War II as a way to increase the Treasury’s flexibility in managing government finances. Since 1939 Congress has imposed an aggregate limit on debt issued by the Treasury, which applies to debt held by the public—individuals and foreign governments—as well as money borrowed from government accounts such as the Social Security and Medicare Trust Funds. Since World War II, Congress has enacted nearly a hundred separate measures altering the debt ceiling, usually increasing it, and by a series of actions has raised the ceiling by almost $10 trillion since 1993.

While the limit is legally binding, it is not strictly necessary to the budgetary process. The Congressional Budget Office calls it an “ineffective means of controlling deficits,” since the decision to spend an amount that would require borrowing is “made through other legislative actions.” Congress creates the need for debt issuance by approving spending in excess of revenues. Once the debt level reaches the statutory ceiling, it is too late for Congress not to raise the limit without reneging on spending it has already approved or defaulting on outstanding debt.

Why, then, would we maintain what former Federal Reserve Chairman Alan Greenspan calls a budgetary system akin to “suspenders and belts”? The usual explanation, articulated by the CBO, is that necessary increases in the ceiling “bring debt levels to the forefront of policy debate.” This is certainly true now, as House Republican leaders are demanding that the debt ceiling increase be accompanied by substantial long-term spending cuts. But given the political climate of the past two years, one wonders whether an obscure institutional mechanism was needed to get people to pay closer attention to the level of federal debt.

Against whatever benefits accrue from increased publicity for the national debt must be weighed the costs of political haggling over the debt ceiling. The trouble with threatening not to increase the debt limit when it is nearly even with the debt level is that there is no viable alternative. Suppose that in early July President Obama calls the Republicans’ bluff, foregoing the debt limit increase to avoid the spending reforms they demand. In that case the government has two options: Either cut off borrowing by immediately reducing total spending by 42 percent—the amount currently financed by loans—or refuse to repay creditors, either by simply not paying or by printing money and paying them in inflated dollars. Either course would have catastrophic macroeconomic consequences, and the latter would likely destroy the government’s ability to borrow.

Recognition of this reality would eventually lead to a compromise. The critical question, however, is how long this would take. The Treasury sells debt to individuals and governments in exchange for commitments to repay the debt with interest within a certain period of time. If Washington gridlock prevents a debt limit increase by the July 8 deadline, the Treasury could begin missing payments, resulting in higher interest rates on federal borrowing to compensate creditors for the greater perceived risk of lending to the Treasury. In addition to making the federal spending trajectory even less manageable, Fed Chairman Ben S. Bernanke says a default would be a “recovery-ending event” because of the broader impact of higher interest rates and shattered confidence in the deadbeat government. Even if we never reach the point of default, there is bound to be uncertainty about the timeliness of Congress’s action to increase the debt ceiling, which could by itself increase the cost of federal borrowing.

The irony of all this, as the Washington Post’s Ezra Klein has pointed out, is that it is precisely this kind of debt crisis that GOP congressmen are trying to prevent by demanding budgetary reform in exchange for a debt limit increase. The dangerous fight we are about to experience, as well as previous instances of haggling over the debt ceiling, suggest that the statutory limit should not exist at all. Given the national mood, it may be necessary to couple its elimination with long-term debt reduction legislation, or to wait until the budget trajectory substantially improves. Until then, we can only hope partisan bickering does not provoke an imminently preventable budget crisis.

Peyton R. Miller '12 is a government concentrator in Winthrop House. His column appears on alternate Tuesdays.