Raising the Debt Ceiling…Again…Maybe

The US is once again around the precipice of default on its national debt – not due to a fundamental inability to generate and collect tax revenues (the la Greece), but because of political shenanigans over the country’s financial debt ceiling.

The Treasury Department projects that after November 3, the federal government won’t have enough cash on hand to pay for its bills and obligations without borrowing in excess of the current federal debt limit, currently US$18.1 trillion. If Our elected representatives does not act by then, the Treasury would have no option but to renege on its guarantees, an action that could possess serious consequences for the nation’utes economy – and well beyond.

It’s uncertain if we’ll observe more political shenanigans this week – like the attachment of amendments that may pose a problem for quick passage – as Congress considers whether and how much to raise your debt ceiling. The latest reports suggest House Speaker John Boehner and also the White House are negotiating a two-year deal that would suspend the debt ceiling until 2017.

That would be a welcome development, but dealing with this dangerous drama every year or two (or multiple times in a single year) begs an important question: why have such limits when the spending this seeks to constrain was already approved by Congress, and when the consequences of not raising it could be so dire?

Origins of the debt ceiling

First, a quick primer on government finance. When annual outlays (spending and transfers) exceed tax revenues, the government runs a budget deficit and must after that borrow funds to make in the difference. The government does so by selling Treasury securities to the public in exchange for cash.

Treasury securities are debt instruments, which are, essentially, promises to repay the face value (the dollar amount borrowed) in addition interest at an agreed-upon date. These types of securities are ultimately backed by the Treasury’s ability to collect future taxes to cover these types of payments. The total face worth of the federal government’s outstanding financial debt – the amount it currently owes it’s bond-holding creditors – is equal to the accumulation of all past annual deficits.

The legal ceiling on US debt places a legal upper bound around the size of this outstanding financial debt; that is, on how much the federal government can borrow.

The ceiling has been around since 1917, when Congress adopted it to strengthen the legislative branch’s control over spending and income taxes, then primarily determined by the president. Besides the US, only Denmark includes a statutory debt limit (even though in Denmark the limit is much less amenable to political mischief than here).

The ceiling’s weak rationale

The economic arguments for having the debt ceiling are exceedingly weak.

First, the original rationale for the statute – to provide a better balance associated with power between lawmakers and also the president over who controls fiscal policy – is obsolete. The Congressional Budget Act of 1974 now specifically explains procedures for how Congress would be to participate in the annual budget procedure. The ceiling is, at best, redundant in light of it’s initial purpose.

Second, the specific restrict set by the law – at first around $12 billion and now at its current level after having been raised 78 times because 1960 – is completely arbitrary and never linked in any meaningful method to the scale of the economy.

Were a debt limit deemed a good policy tool, the restrict would need to account for inflation. Or else, generally rising prices, actually at current low rising cost of living rates, would eventually drive nominal borrowing beyond the set limit anyway, even if there have been no changes in real (inflation-adjusted) spending and borrowing.

One option would be in order to index the nominal limit to a measure of inflation, like changes in the consumer price index. Another would be to impose the actual limit on debt like a proportion of the nation’s complete output. The latter alternative might at least have the advantage of braiding the ceiling to the sources available for paying off the debt.

Third, even if we grant the one possibly sound argument for sustaining a limit – that it disciplines financial policy – there are better ways to achieve this goal.

The current setup is totally divorced from the annual spending budget process, and is thus inefficient and inconsistent. In addition, the consequences of not raising the limit are extreme as well as potentially harmful to the overall economy.

Indeed, the mere anticipation of government default heightens uncertainty, damages the actual government’s reputation and expert, and increases borrowing expenses (ultimately borne by citizens). For example, a major scare over raising the ceiling in 2011 led to the loss of the national government’s AAA credit rating at Regular & Poor’s, which blamed political brinkmanship over both the ceiling and broader debt debate for that downgrade.

In addition, given the need for US debt as an worldwide financial asset, a US default could lead to yet another global financial crisis, among other unintended consequences.

A better way to control spending

Here is a better method to limit the role of government in the economy and promote fiscal discipline: rescind the current debt roof but impose a statutory limit on the annual outlays of the federal government as a proportion of the nation’s income.

Such a ceiling would discipline federal investing through the established annual budget process. It would force the actual American people, through their politics representatives, to determine how much of the nation’s productive capacity the federal government ought to control, and how to allocate individuals limited resources across alternative uses.

In addition, a roof on outlays is better than a roof on the debt-to-GDP ratio or even a well balanced budget amendment, since nor of those alternatives necessarily limitations the overall size of the government sector. I do not consider a country in which the government always has a balanced spending budget – but that controls, state, 50% of the nation’s GDP – a country with a lot of federal fiscal self-discipline.

Yes, there are always the opportunities with regard to political mischief, and a roof on spending might have its own unintended consequences. There are certainly many beneficial refinements to think about, such as a spending limit that varies with the state of the business cycle (rising during recessions and falling with expansions).

However, I would predict that such a strategy would rein in spending and limit the government’s role in the economy more effectively, along with less uncertainty and fewer harmful side effects, than the ill-advised, counterproductive, as well as unnecessary debt ceiling we’ve.

Explainer: what’s the debt ceiling as well as why it’s an obsolete way to control spending is republished with permission from The Conversation