WASHINGTON – After veering away at the last minute from a fiscal cliff over federal spending Congress and the White House appear to be racing toward another economic precipice, this one dealing with the nation’s debt limit.
According to outgoing Treasury Secretary Tim Geithner, the federal government hit its debt limit – the amount of money the Treasury can permissibly borrow to fund governmental functions – on Dec. 26, 2012. The Treasury has taken steps to avoid immediate shortfalls but the federal government could soon find itself in default of its obligations if the ceiling, set at $16.4 trillion, isn’t raised.
“Our numbers show that we have less time to solve this problem than many realize,” said Steve Bell, senior director of the Economic Policy Project at the Bipartisan Policy Center. “We estimate that Treasury will exhaust its borrowing authority and no longer have sufficient funds to meet its obligations in full and on time at some point between February 15 and March 1. It will be difficult for Treasury to get beyond the March 1 date in our judgment.”
President Obama tussled with congressional Republicans over the most recent debt limit increase during the summer of 2011, ultimately resulting in the Budget Control Act of 2011, which not only raised the ceiling but cut scheduled government spending increases. On Aug. 5, 2011, four days after the legislation became law, Standard & Poor’s downgraded the federal government’s credit rating for the first time in history, lowering it from AAA to AA+, a move essentially making it more expensive to borrow money.
The General Accounting Office, in a report issued last July, found that the congressional delay in approving the 2011 debt ceiling hike cost the Treasury $1.3 billion.
“Congress usually votes on increasing the debt limit after fiscal policy decisions affecting federal borrowing have begun to take effect,” the report found. “This approach to raising the debt limit does not facilitate debate over specific tax or spending proposals and their effect on debt.”
Congress, the GAO said, “should consider ways to better link decisions about the debt limit with decisions about spending and revenue to avoid potential disruptions to the Treasury market and to help inform the fiscal policy debate in a timely way.”
This go-round, with congressional Republicans again insisting on spending concessions before approving any increase, the president has vowed that he will not engage lawmakers over the limit, asserting at a news conference on Jan. 14 that he refuses to negotiate “with a gun at the head of the American people.”
“It would be a self-inflicted wound on the economy,” he said. “Even entertaining the idea of this happening, of the United States of America not paying its bills, is irresponsible. It’s absurd.”
Republican leaders have not backed down. Some lawmakers are demanding budget cuts equal to the amount of the debt limit increase.
“The American people do not support raising the debt ceiling without reducing government spending at the same time,” said House Speaker John Boehner (R-Ohio). “The consequences of failing to increase the debt ceiling are real but so too are the consequences of allowing our spending problem to go unresolved. Without meaningful action the debt will continue to act as an anchor on our economy, costing American jobs and endangering our children’s future.”
So how will this play out? There exist several potential scenarios:
DEFAULT
Opinions differ on what might happen in the immediate aftermath if Congress refuses to act and the Obama administration finds its hands tied. The U.S. defaulting on its debts is uncharted territory. One analysis finds that the Treasury will collect $277 billion in revenue between Feb. 15 and March 15 and face $452 billion in scheduled payments. That means about $175 billion in obligations – 39 percent of the government’s tab — will go unpaid.
Geithner acknowledged Internal Revenue Service refunds, Medicare, Medicaid, Social Security, and interest payments could be affected.
“If we reach the X Date and Treasury is forced to prioritize payments, handling payments for many important and popular programs will quickly become impossible, causing disruption to an already fragile economic recovery,” Bell said.
The Bipartisan Policy Center acknowledges the Treasury may try to prioritize some payments over others but the department could find it has neither the legal authority nor the technical capacity to do so. More likely, it maintains, the Treasury will collect sufficient revenue to make an entire day’s worth of payments at a time — meaning all payments would be made in turn but everyone anticipating funds from the government would experience delays.
Problems don’t end there. In the month following the start of any default about $500 billion in debt is expected to mature. Normally, the Center said, this would be rolled over by issuing new debt, an avenue rendered unavailable sans a debt limit increase.
Those issues could seem inconsequential compared to the anticipated reaction of the financial markets if the limit is not raised. Investors are expected to dump Treasury bills, pumping up interest rates and leading to inflation. The stock market could panic, leading to a sell-off with an impact felt near and far.
But J.D. Foster, a senior fellow in the Economics of Fiscal Policy at The Heritage Foundation, argues that the only way the federal government would default on its debt is if the Treasury opts to do so. There is sufficient money entering the system to meet debt service if no agreement is reached although such a move likely would result in a partial government shutdown
“This means certain governmental functions are suspended because the Treasury lacks the authority to spend — not because it lacks the means to spend,” Foster said. “Further, a government shutdown applies primarily to those activities funded by what is called ‘discretionary’ spending, essentially the day-to-day operations of the government, as opposed to entitlement spending such as Social Security and Medicare.”
Foster expressed confidence the Treasury will “take the actions necessary to preserve the full faith and credit of the U.S. government and avoid defaulting on debts due.”
The Obama administration anticipates governmental spending would have to be cut by 40 percent under the package described by Foster. Sen. John Cornyn (R-Texas), in an op-ed piece for the Houston Chronicle, asserted that “it may be necessary to partially shut down the government in order to secure the long-term fiscal well-being of our country, rather than plod along the path of Greece, Italy and Spain.”
Cornyn said Republicans “are more determined than ever” to implement spending cuts and restructure entitlement programs to secure the nation’s long-term integrity.
“If we don’t reduce spending and reform our three biggest entitlement programs – Medicare, Medicaid and Social Security – then we will strangle economic growth, destroy jobs and reduce our standard of living,” he said.
Obama said that outline carries dire consequences.
“If congressional Republicans refuse to pay America’s bills on time, Social Security checks and veterans’ benefits will be delayed,” Obama said. “We might not be able to pay our troops or honor our contracts with small-business owners. Food inspectors, air traffic controllers, specialists who track down loose nuclear materials wouldn’t get their paychecks. Investors around the world will ask if the United States of America is in fact a safe bet. Markets could go haywire. Interest rates would spike for anybody who borrows money, every homeowner with a mortgage, every student with a college loan, every small business owner who wants to grow and hire. It would be a self-inflicted wound on the economy. It would slow down our growth, might tip us into recession, and ironically, would probably increase our deficit.”
AGREEMENT
The Obama White House and Congress have peered into the abyss before and arrived at solutions, although most proved no more than temporary. Congress balked at raising the debt limit to $16.4 trillion in August 2011 and demanded budget cuts to attract support. The administration and congressional leaders finally settled on $917 billion in cuts over 10 years in exchange for a $900 billion hike in the debt limit. Spending under the deal therefore was cut deeper than the increase in the debt limit.
This time, Republicans, who control the House, are seeking a reported $1.2 trillion in budget cuts in exchange for raising the debt limit. Obama insists he’s not going to play the GOP’s game, stressing that lawmakers “will not collect a ransom in exchange for not crashing the American economy.”
“Raising the debt ceiling does not authorize more spending — it simply allows the country to pay for spending that Congress has already committed to,” Obama said. “These are bills that have already been racked up and we need to pay them. So while I’m willing to compromise and find common ground over how to reduce our deficits, America cannot afford another debate with this Congress about whether or not they should pay the bills they’ve already racked up.”
Republicans remain equally adamant. Senate Republican Leader Mitch McConnell, of Kentucky, has vowed to include budget cuts in the discussions.
“Avoiding this problem will only make it worse, which is why many of us view the upcoming debt limit debate as a perfect opportunity to face up to Washington’s spending,” McConnell said.
UNILATERAL ACTION
In a recent letter to Obama, four high-ranking Senate Democrats, led by Senate Democratic Leader Harry Reid, of Nevada, urged him to, if necessary, raise the debt ceiling without congressional approval.
“In the event that Republicans make good on their threat by failing to act, or by moving unilaterally to pass a debt limit extension as part of an unbalanced or unreasonable legislation, we believe you must be willing to take any lawful steps to ensure that America does not break its promise and trigger a global economic crisis — without Congressional approval, if necessary,” the group advised.
Lawmakers supporting unilateral presidential action cite the 14th Amendment to the Constitution, which says in part, “the validity of the public debt of the United States, authorized by law, shall not be questioned.” But Republican lawmakers insist any such effort would be unconstitutional, noting that the framers granted the power of the purse to Congress.
“Democrats in Washington are falling all over themselves in an effort to do anything they can to get around the law — and to avoid taking any responsibility for Washington’s out-of-control spending,” McConnell said.
The White House has said it does not plan to invoke the 14th Amendment.
TRILLION DOLLAR COIN
During the 2011 debt limit showdown, John Balkin, a professor of constitutional law and the First Amendment at Yale Law School, used his blog, Balkinization, to offer a unique way out of the mess.
A loophole in federal law allows the government to mint platinum coins in any denomination it chooses. Balkin suggested, whimsically at first, that the U.S. Mint simply produce a couple platinum coins with a value of $1 trillion each, which would be legal tender. The Mint would deposit the coins in its account at the Federal Reserve. The president could then direct the Federal Reserve to transfer the money to the Treasury. The government could then afford to pay its bills without relying on Congress to raise the debt limit. And since the money would only be used to maintain federal spending at existing levels, inflation wouldn’t be a problem.
Republicans dismissed the proposal as a gimmick.
“Rather than offering any plan to break the spending habit that’s causing the problem, Democrats are looking at everything from the ridiculous — printing a trillion-dollar coin — to outright abdication of Congressional responsibility,” McConnell said.
The Treasury has put the kibosh on the proposal, claiming the law was intended to produce platinum coins as a substitute for raising the debt limit.
“There are only two options to deal with the debt limit — Congress can pay its bills or it can fail to act and put the nation into default,” said White House Press Secretary Jay Carney.
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