Tag Archives: debt ceiling

Keep the Debt Ceiling

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“Manufactured crisis” is the term going around to describe the near-failure of Congress to raise the debt ceiling. Mitch McConnell says that we can expect more of them in the future. It’s not surprising that big-government types want to get rid of the debt ceiling altogether, but even some of the cool people are getting in on the action. “Get rid of the debt ceiling, for God’s sake,” says Scott Sumner. “Now more than ever the debt ceiling has to be permanently removed,” says Adam Ozimek. I’m not for manufactured crises, but this seems like a severe overreaction that would have really bad long-run consequences.

The argument for getting rid of the debt ceiling goes like this: Congress has already approved federal spending. Increases in the debt ceiling merely authorize the executive branch to spend what the legislative branch has ordered it to spend, so it is redundant. Furthermore, Congress has now discovered that the debt ceiling can be used as a source of gridlock (or “hostage-taking” or “terrorism,” depending on how shrill you want to get). Most governments don’t have debt ceilings; they work just fine. So the debt ceiling creates an opportunity for political opportunism and pointlessly increases our risk of a big crisis.

This argument strikes me as shockingly naïve. First of all, to get rid of the debt ceiling would be to vastly expand the power of the executive branch. The US Constitution lists borrowing as an Article I power. “The Congress shall have Power…To borrow Money on the credit of the United States.” Giving the executive branch the power to borrow on the credit of the US whatever it interprets to be necessary could have terrible consequences. For instance, current Constitutional jurisprudence seems to give Congress the authority to declare war, but no mechanism by which to undeclare war. Wars end when the executive branch says they end. However, at present Congress can at least de-fund a war. If the debt ceiling were eliminated, once war had been declared, the executive branch could prosecute it basically forever, even if Congress disapproved. The president could borrow whatever money was necessary to do all the spending that Congress ordered, plus the money for the war. And when you factor in that the Obama administration seems to have blatantly ignored the War Powers Resolution in its action in Libya, this should be cause for serious alarm among anyone with even a modicum of sense. The left especially, which complained incessantly about expansions of executive power during the Bush administration, if it has any principles left should oppose giving the executive branch any freer rein.

Furthermore, it’s simply not true that every Congress approves of all federal spending. Congress passes a discretionary budget every year, but much of federal spending is “mandatory,” meaning it is not subject to the ordinary how-a-bill-becomes-a-law process. On entitlements, for instance, some past Congress approved a given path of spending, but the current Congress can only change that path if they can override a presidential veto (or induce a non-veto). Assuming no veto-overrides, to cut discretionary spending, you need both houses of Congress. To cut entitlement spending, you need both houses plus the President. So the structure of the spending power is in fact different with discretionary versus “mandatory” spending. Faced with an executive branch that opposes cuts to entitlement spending, Congress will never be able to cut spending if they cannot force a cut through the debt ceiling. If all federal spending were discretionary, then there would be some merit to the claim that the debt ceiling is redundant; since some spending cuts are subject to a presidential veto, the debt ceiling provides an important non-redundant tool to force those cuts.

More generally, I would remind people that decreasing the holdout problem with respect to spending increases the holdout problem with respect to cutting spending. If you agree that the US needs to drastically cut entitlements over the medium term (i.e., if you are paying attention), you should want to decrease the holdout problem for spending cuts, not for spending increases.

So what about the severe crisis that will result if the US bumps up against the debt ceiling, gets downgraded, or delays payments? I agree that this will be a manufactured crisis, but those who favor spending more seem to deserve as much, if not more, of the blame as those who oppose borrowing more. But it seems the biggest blame should be laid at the feet of those who make our economy so fragile with respect to a single security. The best way to avoid a crisis in the future is to take steps now to make financial institutions more robust. First, eliminate rules that will trigger huge sell-offs of T-bills if when the US loses its AAA credit rating. Eliminate the favorable tax treatment of debt and improve the tax treatment of equity (I facetiously call this “Islamic banking lite”). Allow checkable brokerage accounts. Increase the average maturity of US debt to give the government some leeway with respect to seigniorage in the event the crisis occurs.

And of course, the ultimate solution to the debt ceiling issue is to spend less. Even if you oppose cutting spending during a recession, it’s hard to justify a debt ceiling that is as high as the US’s. If the output gap of a recession is 8 percent of GDP for 4 years, even if there is no monetary stimulus, that justifies a debt ceiling that is 32 percent of GDP, not 100 percent or more. In reality, there can be more monetary stimulus and fiscal stimulus is pretty ineffective, so even 32 percent of GDP seems like excessive borrowing across the business cycle.

My bottom line is that the US is a big, diverse economy. As it has gotten more diverse, interests have come into greater conflict. The result will be either gridlock in Congress, consolidation of executive branch power, or devolution of power to local authorities (at which scale there is less conflict) and the market. We should take this last path, and the quickest and least painful way to get there is to keep the debt ceiling and make smart reforms to spending and the financial system. Eliminating the debt ceiling will ensure that power continues to be consolidated and that spending will be harder to cut.

ET and the Debt Ceiling, a Socratic Dialogue

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ET: Greetings, Earthling! I am a visitor from another star system, searching the galaxy for intelligent life. May I ask you a some questions about your planet?

Earthling: Of course, I am happy to be of assistance.

ET: Excellent. Will you tell me, Earthling, what is this debt ceiling that everybody is discussing?

Earthling: The debt ceiling is the maximum amount that the government is authorized to borrow.

ET: What is a government? I am not sure we have those in my star system.

Earthling: A government is the organization that controls a particular territory.

ET: Ah, we do have those in my star system. We call them “gangs.”

Earthling: Well, we have gangs too, but governments are different. They provide public goods that are paid for through taxes.

ET: What are taxes?

Earthling: Payments to the government.

ET: I see, so people make voluntary contributions to the government and they get public goods in return. This makes sense now.

Earthling: Well, no. Taxes are not exactly voluntary.

ET: What do you mean?

Earthling: If the government assesses someone with a tax, and he resists paying it, the government will send him to jail.

ET: And what if he will not go?

Earthling: The government is very powerful; it will seize the tax resister and punish him by whatever means necessary.

ET: I see. So the government uses the threat of violence to take money from people who do not wish to pay. This sounds a lot like the gangs that exist in my star system, but I will accept your word that there is some nuance that as a visitor to your planet escapes me. But Earthling, this debt ceiling matter still puzzles me. I fail to see why it matters how much the government is authorized to borrow. If a human manages to retain any resources after the government has taxed him, why would he turn around and give those resources to the government? The government would just keep it. So whatever the government is authorized to borrow, there will be no borrowing.

Earthling: The lenders expect to be paid back.

ET: In my star system, someone who lent to a gang would not expect to be paid back.

Earthling: Here they expect to be paid back with interest.

ET: Oh, now I get it. People lend to the gang—excuse me—I mean, government as a risky, high-reward strategy. Interest rates on money lent to the government must be very high. Tell me, am I right?

Earthling: No, on the contrary, they are very low.

ET: Impossible.

Earthling: It is true.

ET: I am truly puzzled, but perhaps if I ask more questions it will make sense to me. Tell me Earthling, why does the debt ceiling need to be raised? Is it very low?

Earthling: It is $14.294 trillion.

ET: Can you put that number in context?

Earthling: That is for an economy that produces $15.018 trillion per year.

ET: So your government wishes to borrow more than 95 percent of annual output. Now it is beginning to become clear. Your planet must be undergoing a dire calamity. Tremendous resources are necessary to cope with it, more than can be raised through violence alone. Tell me, what is the calamity that your planet is undergoing?

Earthling: Well, there is an economic recession, but it is not exactly a dire calamity. The real dire calamity will occur if the debt ceiling is not raised.

ET: I do not understand. If there is no dire calamity, why must the debt ceiling be raised?

Earthling: If the government cannot borrow money, it will not have enough to pay for all the programs in its budget and to pay the interest on its previous loans.

ET: I see. In that case, those who run the government must be wise and universally respected humans. People trust them to make good decisions about how to spend the money. Is this so?

Earthling: Not exactly. Everyone agrees that those who run the government are idiots.

ET: What process is there for determining who runs the government? Is it through violence?

Earthling: No, the voters decide.

ET: Who are the voters?

Earthling: Nearly everyone is a voter.

ET: The voters must be idiots themselves if they select idiots to run the government.

Earthling: Uhhh…

ET: No matter. Tell me, if the debt ceiling is increased, on what public goods will the government spend the proceeds?

Earthling: Well, the spending will not be on public goods.

ET: But you said earlier that the government spends money on public goods.

Earthling: That may have been a slip-up on my part.

ET: In that case, how will the money be spent?

Earthling: The government is fighting three wars.

ET: Ah, I should have understood this earlier. The government is using the money to open up new revenue streams. It will conquer new territory and then increase its tax receipts.

Earthling: No, they are not those kind of wars.

ET: What kind of wars are they?

Earthling: Humanitarian ones.

ET: How can a war be humanitarian?

Earthling: We are imposing our form of government on other territories.

ET: You mean, the form of government in which idiotic voters elect idiotic humans to borrow money to fight wars so that other idiotic voters can do the same?

Earthling: Yes.

ET: Is that everything on which the money will be spent?

Earthling: No.

ET: On what else?

Earthling: Also on the elderly.

ET: What do you mean?

Earthling: The government transfers large sums of money to old people.

ET: To what end?

Earthling: To pay their living expenses and for their medical care.

ET: It must be very important to keep the elderly alive if the government is willing to borrow so much money to pay for their expenses. They must be very productive members of your society.

Earthling: Well, not exactly. Most of them are retired.

ET: What does retired mean?

Earthling: It means they don’t work.

ET: They don’t produce anything?

Earthling: Correct. But that’s not the point. We value the elderly in our society for their own sake.

ET: I see. So it is common for young people on your planet to frequently communicate with the elderly, and to volunteer to spend time with them, because they are so highly valued.

Earthling: No, young people do not generally like to do that.

ET: Tell me, what would happen if the government did not make these payments to the elderly?

Earthling: Many of them would be poor, and without medical care many of them would die earlier.

ET: It must be the case that becoming old is unforeseeable, then. People do not save enough for old age because they do not expect to live long enough to become old.

Earthling: No, most people expect to become old.

ET: And the medical care must give them several additional years of high-quality life, no?

Earthling: It extends their life somewhat, but much of the budget is spent in the last year of life, in which the recipient suffers quite a bit.

ET: So the spending is on unproductive people who face a foreseeable condition and who are given a short, temporary, and miserable reprieve on death?

Earthling: I suppose, but you must understand, the elderly constitute a high percentage of the voters. They have a lot of power.

ET: So in addition to those who want to spread your dysfunctional system of government around the planet through wars, the elderly are also to blame for your debt ceiling troubles.

Earthling: That’s right.

ET: You said earlier that it would be a dire calamity if the government did not raise the debt ceiling. How so?

Earthling: If the government cannot pay the interest due on its debts, its bonds will plummet in value. As a result, all of the financial institutions that hold government bonds will lose a large fraction of the assets that guarantee their liabilities. They will go bankrupt, the market for credit will disappear, and there will be a severe depression.

ET: That does sound bad. Why is anyone opposed to raising the debt ceiling, then?

Earthling: Some people are trying to use their refusal to raise the debt ceiling as leverage to get other political concessions.

ET: In my star system, we call this “the holdout problem.”

Earthling: Here it’s “checks and balances.”

ET: What are these holdouts trying to get?

Earthling: They want to cut government spending.

ET: I see. So they want to end all of the wars and spending on the elderly that have caused the debt to rise so high.

Earthling: No, they want to cut a small bit of the spending on the elderly and keep the wars.

ET: How much do they want to cut?

Earthling: Well, there are multiple proposals. Harry Reid has one. John Boehner has another.

ET: John Boehner. Is he the orange human?

Earthling: Correct. In all of the plans that have been proposed so far, spending over the next 10 years will be higher on average than it was last year, in which we had record deficits.

ET: I see. So these plans do not actually cut spending.

Earthling: That’s right.

ET: What will happen if the debt ceiling is increased?

Earthling: The crisis will go away.

ET: Bonds will not plummet in value?

Earthling: Well, there is concern that if the government does not balance its budget over the long run, its debt will be downgraded, its bonds will plummet in value, and there will be a severe recession anyway.

ET: But with the debt ceiling issue off the table, those who run the government will certainly pay more attention to the long-run balance of the budget, will they not? And thereby avoid the crisis?

Earthling: Hmmm.

ET: I mean, these long-run budget issues must have become known only recently if they are now, all of a sudden, a problem.

Earthling: The government has known about its long-run budget problems for many years and it has done nothing.

ET: And it has done nothing about them?

Earthling: Correct.

ET: I see. But the future will be different. It will do something about the problems after the debt ceiling has increased.

Earthling: Maybe.

ET: Well, thank you for answering my questions. I regret that I did not find what I was looking for on Earth, but perhaps after a few million more years of evolution, I shall return.

The Political Economy of Debt-Ceiling Chicken

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Lots of smart economists are worried about what will happen if the US federal debt ceiling is not raised by August 2, which is when the Treasury Department has estimated that it will bump up against the $14.2 trillion limit. The worst-case scenarios include a run on Treasuries and a collapse of the financial system. I don’t have any special insight into what will happen, but I think my perspective as a political economist gives me a contrarian view. I’d probably vote against an increase in the debt ceiling if I were in Congress, though not for reasons that any current member of Congress would be likely to endorse.

The fight over the debt ceiling is widely viewed as an argument over the size and scope of government. Superficially, this is correct: the Republicans have little political power with which to prosecute the argument, so their best strategy is to act erratic and crazy, and to threaten mutually assured destruction if Democrats do not agree to their terms. Democrats are trying to determine exactly how much of Republicans’ behavior is an act, and how much is due to their actual craziness, which one imagines is difficult to disentangle, particularly since accusations of craziness are fashionable in modern politics and it’s difficult at some point not to believe your own PR. It is basically right to characterize the argument over the debt ceiling as a slow-motion game of chicken.

But on a deeper level, there is much more going on. While the argument over the debt ceiling is about the size and scope of government, my thoughts on this issue are much more colored by the scale of government. If we think about the scope of government as the spheres over which the government has influence, and the size of government as the percentage of GDP that is constituted by the public sector, the scale of government is the denominator of the size variable. How much territory, how much economic activity, how many people should be united under a single government?

While people have differing ideological priors about the optimal size and scope of government (full disclosure: my priors are small to none), I don’t think there is nearly the same partisan disagreement over the scale of government. Republicans and Democrats agree: the optimal scale of government is basically the status quo United States of America. This agreement can hardly be claimed to be the result of any serious reflection by either party. Yes, there are disagreements about federalism and nation-building, and these have some bearing on the effective scale of government. But neither party wants to split the USA in two, or to take over the rest of North America; this is simply not an issue that is very salient in modern politics.

While the observed size and scope of government gets worked out through political wrangling, the observed scale of government comes about more indirectly. There are conquests, and the EU, and decisions to secede, and to some extent these are intentional, but for the most part the scale of government is a product of human action but not of human design and also of real economic forces; if your mind immediately goes to political transaction costs, value heterogeneity, etc., you are on the right track.

What we have in the debt ceiling fight is not just a political argument, but a political-economic equilibrium working itself out. Whatever your views on the proper size and scope of government, the scale of the US government is probably too big for the institutions that compose it. There are too many heterogeneous values, too many interest groups, too many hold-up problems. When politicians play chicken with financial markets on the line, that’s a sign that politics is pretty dysfunctional. My point is not to castigate the politicians involved but to draw attention to the fact that such games of chicken are exactly what you would expect to observe if the scale of government were too big.

Failing to approve an increase in the debt ceiling gives politicians the chance to prove me wrong. If forced to come together and work out a deal to balance the budget in a hurry, could they do it? If so, then great. If not, then the inevitable day of fiscal reckoning has come; better for it to come now than later when an irreparably dysfunctional political system has made the problem even worse.