With an early August deadline looming for an agreement to increase the federal debt limit, both commentators and financial markets are becoming increasingly concerned that hard-liners in Congress will succeed in preventing an agreement from being reached. If that happens, then the U.S. government will begin to default on its obligations.
The consequences of a default, as I discuss below, are likely to be catastrophic. Even if we succeed in avoiding such a default, however, any respite will only be temporary. Unless the debt limit is definitively repealed or negated, the United States faces the prospect of continuing political crises, each one precipitated by the prospect of reaching the debt limit. More of the same is not an acceptable way to run our nation’s fiscal policy.
What Is the Debt Limit, and Why Does It Matter?
Until recently, the debt limit was little more than a political talking point—mildly useful to a President’s political opponents, who could occasionally grandstand and talk about the government’s supposed irresponsibility. The law setting the limit was, however, an unnecessary piece of legislation. Congress and the President already limit the national debt through their decisions about how much money to spend and how much revenue to collect. If they do not think that the debt should go above some particular limit, then they have the power to stop it from doing so.
The provision of the U.S. Code that purports to limit the aggregate national debt, moreover, acts in an especially perverse fashion. By providing politicians with an opportunity to pass one law that will be at odds with other laws, the debt limit can put the government in the position of making good-faith agreements with people and businesses to make certain payments, only to abrogate those agreements when the aggregate debt of the federal government goes above some arbitrary limit.
Until now, this perversity had never actually become operative. And that fact had allowed everyone to take the existence of the debt limit for granted, without seriously considering whether the debt limit law is even a permissible exercise of legislative power. Unfortunately, however, those innocent days are behind us, and we must now confront the debt limit’s folly as a matter of policy, as well as its illegitimacy as a matter of law.
The debt limit is foolish as a matter of policy, because there is no good reason to limit the government’s debt to some arbitrary level. Economists always expect the federal government’s debt level to rise, for completely healthy reasons. Between the effects of inflation, a growing population, and an expanding economy, it would be unusual indeed to imagine that the federal government should have the same level of debt in 2011 that it had in, say, 1961. Just as wealthier families and successful businesses can easily handle higher levels of debt than their less fortunate counterparts, the government of a growing country can also handle increased debt as time passes. This is especially true if the government is—as it should be—borrowing money to engage in public investments (such as investments in education, basic research, and nutritional programs) that later pay off, in the form of higher national income over time.
In other words, there is no good economic reason to think that a country’s debt should not rise. Even those who favor paying down the national debt to zero have not seriously explained why a government should be prevented from being run in the way good businesses are run—and nearly all well-run businesses are heavily in debt at all times. A debt limit, therefore, is based on the false premise that the government’s debt should be held to some arbitrary level, subject to decisions by Congress to change that level on an ad hoc basis.
The Consequence of Hitting the Debt Ceiling: Economic Disaster Ahead
Although there is no good reason for the debt limit to exist, as I have explained above, the law that establishes that limit remains on the books, currently limiting federal borrowing to just under $14.3 trillion. We formally reached that limit several weeks ago, and the U.S. Treasury is currently engaged in a juggling act that allows the federal government temporarily to continue to meet all of its obligations. The various methods available to keep all of the balls in the air will soon be exhausted, however, meaning that we will soon reach a point where the federal government will not be able to make payment on its obligations under the terms that were agreed upon.
Some have argued that the consequences of such a default will be minor, at worst. Such beliefs, however, seriously misunderstand the economic mechanisms that can readily turn a default into a larger crisis. Modern economies, as we learned to our regret in the financial crises that led to the Great Recession, are surprisingly fragile financial organisms that can be brought to their knees by seemingly minor events. In 2008, for example, most people could not have imagined the damage that would be wrought by the bankruptcy of Lehman Brothers—an institution that few outside of financial circles had even heard of—or by financial instruments called credit default swaps, which were also foreign to the average American.
Now, however, we are not talking about obscure banks or esoteric financial instruments. We are talking about the U.S. government’s failing to pay its legal obligations. Setting morality aside, the consequences of such a default are almost too awesome to contemplate. Even so, some Wall Street analysts have been trying to determine the type and extent of damage that the government’s failure to meet any of its obligations would inflict on the economy.
One survey of financial players suggested that even a brief default—one followed nearly immediately by payment in full—would increase the borrowing costs of the federal government by roughly one-half of a percentage point. That would amount to adding about $75 billion per year to the debt over time. In the context of budget debates in which Republicans in Congress refuse to close loopholes to collect even a fraction of that amount in additional tax revenue, default will impose costs that we would be ill-equipped to pay. These higher costs, moreover, would be imposed on an economy that would grow more slowly than it otherwise would have (without the default), making the debt even harder to finance.
Such estimates, however, are based on the assumption that the consequences of a debt crisis will be contained. What seems much more likely, however, is that the financial contagion that we saw in late 2008 would be amplified, as both domestic and global financial planners conclude that the United States is no longer a good credit risk. If we are concerned (as we should be) about how the global financial system would respond to the unfolding debt crisis in Greece, then we should be terrified by the prospect of what would happen if the United States were to default on its commitments.
The problem, after all, is that no one knows just how interconnected all of us have become, both economically and politically. For example, acting as if the government can simply stiff some of its obligees (such as Social Security recipients) in the name of paying others (such as foreign banks or governments who hold U.S. debt), ignores the reality that foreign debtholders will see that the U.S. government is keeping its promises only selectively. While it would surely feel better for foreign debtholders if they were to receive preferential treatment, no one in their right mind would view that as a stable or promising situation. Indeed, if it opted for such selected repayment, the United States would quickly find that few people, businesses, or governments would continue to treat it as a trusted partner.
A Shocking Political Standoff, and a Missed Opportunity
It is, therefore, rather astonishing that we are even having a debate about whether to raise the debt limit. Whatever one might think about the size or scope of the federal government, until recently it seemed unthinkable that anyone would hold the U.S. economy (and ultimately the world’s economy) hostage to political demands.
Nevertheless, what we are observing is a dangerous and unseemly game of political “chicken.” The members of the new Republican majority in the House of Representatives (along with their filibuster-empowered Senate colleagues) have said that they will not agree to increase the debt limit unless President Obama and the Democrats agree to immediate spending cuts on a scale that (according to the most credible economic forecasts) would throw millions of people out of work and threaten to send the economy back into severe recession (or worse).
In brief, the Republicans are saying: “If you’ll agree to cut spending by these amounts, then we’ll agree to raise the debt limit.” President Obama should have said, in response, “We already have laws on the books that will result in our debt’s rising above the current limit. We all—Republicans and Democrats alike—should want the same thing: To protect the good faith and credit of the United States of America. So here’s my offer: If you’ll pass a bill raising the debt limit, I promise to sign it.”
True to his nature as a seeker of compromise, however, the President started down a road that led to the current stalemate. He has made it clear that he will agree to cuts in spending during this negotiation. The only question is how much ground the President and his allies will give up in the process.
The Constitutional Solution: Does the Fourteenth Amendment Invalidate the Debt Limit?
There are, however, some possible alternatives to simply trying to cut the best possible political deal. Bruce Bartlett, a former official in Republican administrations and on Capitol Hill, has—along with some legal scholars—been developing arguments demonstrating that the debt limit is illegitimate as a matter of law.
One such argument is based on Section 4 of the Fourteenth Amendment to the United States Constitution. Nearly everyone is familiar with that Amendment’s “Equal Protection Clause” (which is found in Section 1), but few have thought for even a moment about Section 4, which reads in pertinent part: “The validity of the public debt of the United States … shall not be questioned.”
Section 4 was originally added to the Fourteenth Amendment to prevent Reconstruction-era Southern congressmen from trying to default on the government’s Civil War debts. Even so, just as other constitutional limitations—including, for example, the Equal Protection Clause—apply beyond the circumstances of their original enactment, this constitutional provision is applicable today, and it invalidates the statutory debt limit.
The Supreme Court’s only discussion of Section 4, in Perry v. United States in 1935, included this statement: “Nor can we perceive any reason for not considering the expression ‘the validity of the public debt’ as embracing whatever concerns the integrity of the public obligations” (emphasis in original). While that decision was somewhat muddled in other ways, the Court made clear that Section 4 is not limited to its time period, nor does its import hinge on, for example, distinctions between terms like “repudiation” and “default.” If Congress has enacted laws that create public obligations, then those obligations must be met.
In addition to the constitutional issue, there are other legal arguments now floating about suggesting that Congress’s annual budget bills supersede the debt limit, or that the President’s duties require him to invoke national security concerns to prevent a debt default. (Moreover, there are a few other worthy ideas out there as well.) I do not mean to diminish these arguments by describing them so briefly, but rather to suggest that there is a surprisingly broad (and, it turns out, strong) array of arguments that make the debt limit a dead letter, as a matter of law.
Should We Avoid a Legal Battle? The Case Against Muddling Through
If President Obama were to announce that his plan was to simply ignore the debt limit, there are good reasons to believe that the courts would refuse even to hear a challenge to his decision, and even if they did hear one, he would be likely to win on the merits.
Even so, a winning legal argument is not always a strong political strategy. Therefore, few people expect the President to invoke any of the legal arguments against the validity of the debt limit. Doing so would surely lead to a political reaction the intensity of which the country has rarely seen. Why take such a risk, if we can just quietly find a way to raise the debt limit and move on?
The answer is that this is surely not a one-time crisis. What we have learned in the last few months is that, in the future, action on spending and taxes will no longer occur only within the annual budgeting process. Under those circumstances, why would any of the President’s political opponents ever agree to take the debt-limit weapon off the table? Why would they not agree to extend the debt limit merely by the minimal amount necessary to get the government through another two months of operation, only to revisit the issue—armed with a fresh slate of demands—in an effort to extract still more concessions? For that matter, why would they even allow the extension to go on for as long as two months? Why not two weeks, or two days, or two hours?
We must remember, after all, that we are not facing a “debt crisis,” or a “deficit crisis,” or a “budget crisis.” We are facing a “debt–limit crisis.” In other words, without the debt limit’s artificial and arbitrary requirements, we would currently be facing a budgetary situation that can be handled quite easily in the short run. Moreover, any long-run budgetary problems (and all of these are related to rising health-care costs) could and would be the subject of ongoing lawmaking that can be run through standard governing processes.
In sum, nothing that is happening right now is being driven by anything other than an artificial political standoff.
Because of the debt limit, however, those who are willing to threaten to harm the economy are in a position not just to win this round, but also to win future rounds—and, indeed, to determine how many rounds they want to fight. Without a permanent solution, those who have discovered the usefulness of the debt limit as a political tool will never have reason to stop using it to extract further concessions.
There is every good reason, therefore, for President Obama to view this crisis as only the first of many—if he does nothing to derail the process. With Congress unwilling to repeal the debt limit, the President must negate it.
Even Without a Debt Limit, the Political Process Is Still Broken
What would a world without a debt limit look like? While we would be freed from the immediate crisis and endless repeats of it, it is not as if those who currently are opposed to raising the debt limit would suddenly lack political weapons. They could still use the annual appropriations process to force regular government shutdowns, or to extract other concessions on policy. (Government shutdowns are disruptive and harmful, but debt default is in a category all its own.) They could even shorten the budget process if they like, requiring semi-annual or quarterly budgets, rather than annual ones. So long as they are united, they will still have the ability to make President Obama’s life miserable.
By repealing the debt limit, the only thing the Republicans would give up is the ability to destroy (or, more to the point, threaten to destroy) the economy. Their other tools would surely still allow them to get what they want from the President and the Democrats.
The problem is that the debt limit has become such a symbolic item for anti-government forces that, now, they would never dream of agreeing to “let the debt go up without limit.” Faced with unyielding opposition, and with the prospect of endless debt-limit crises in the months and years ahead, now is the time for the President to take at least this one disastrous weapon out of his opponents’ arsenal.