There is a legal maximum on how much debt the federal government can accumulate—often called the “debt ceiling” or the “debt limit.” According to Treasury Secretary Janet Yellen, the government will hit the current limit in a few days. Using a variety of accounting tricks (like temporarily diverting government pension funds), the government can postpone the day when it cannot pay its bills but only for a few months. Congress and the administration therefore face the following questions: whether to raise the debt limit, by how much, and what, if any, conditions to attach.
Citizens and the media misunderstand the issues surrounding the debt limit. Policymakers often fuel this misunderstanding with misleading statements that distort the debate.
The issue is really quite simple. The debt limit doesn’t cause the debt any more than a thermometer causes a fever. Debt grows when spending exceeds revenues. That’s it.
Congress should abolish the debt limit and replace it with the simple, common- sense rule that automatically authorizes any borrowing necessary to implement any fiscal legislation that affects the federal deficit. This “Gephardt rule” was in place at various times in the past.
Raising the debt limit is not about new spending; it is about paying for previous choices policymakers legislated.
Here are seven things to understand about the debt limit and why it is unnecessary and obstructive.
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The debt limit debates of recent years raised interest rates. Higher interest rates would make solving the long-term fiscal problem harder, not easier, and have ramifications across many sectors of the economy. Net interest payments are already expected to explode over the next 10 years and beyond. Because government bond rates are used, contractually, to determine other interest rates, other interest rates would rise as well. More generally, Treasuries might never again be considered a safe haven. This could generate a variety of additional issues. Banks might classify Treasury holdings as non-performing assets. Some Money Market Mutual Funds would “break the buck”—i.e., fall in nominal value—which could create havoc (as it did in 2008). Some or all federal entities could lose their AAA borrowing status. In general, the disruption to the cornerstone of modern financial markets could have ramifications for the global economy, just as the financial crisis of 2008 spread to the overall economy. With the economy currently teetering on the brink of recession, it would be foolhardy to risk a new worldwide financial panic now.
A desire to change the course of fiscal policy should be manifested in new Congressional initiatives to change the course of future spending and taxes, not in Congressional refusal to pay bills that have arisen from previous Congressional action.
Congress should abolish the debt limit and reinstate the Gephardt Rule so that when new legislation adds to the federal deficit, Congress automatically approves the borrowing needed to finance the new legislation.
Since we know we are going to have to address the limit anyway, why not do it without creating economic damage?
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