Commentary: Debt Ceiling 2012

Commentary: Debt Ceiling 2012

Commentary: Debt Ceiling 2012

Debt Ceiling and Federal Default Q&A
February 21, 2011

What should legislators ask in exchange for increasing the debt ceiling?

“Congress needs to impose a spending limit on all future budgets,” said Antony Davies. “By exchanging the debt ceiling for a spending ceiling, we take tax hikes off the table and focus attention on the source of the deficit problem: spending.”

“After a budget is passed, all discretionary spending allocations should be reduced by the same percentage so that total budgeted spending does not exceed 19 percent of the previous year’s GDP. This way, no single person has to take political heat for cutting specific programs since the cuts are automatic and across the board,” Davies said.

What is the likelihood that such significant spending cuts or limits will be made?

 “The debt ceiling debate is a sideshow because neither party is willing to deal with the real problems we face, such as entitlements,” said David Primo.

“ A focus on the debt ceiling allows both parties the opportunity to score political points, without accomplishing anything.  Even if Republicans are successful in demanding spending cuts in exchange for increasing the debt ceiling, those cuts will do next-to-nothing about our massive deficits,” Primo said.

Will the federal government actually default if the debt ceiling is not raised?

Veronique De Rugy said that technically, if the debt nears its statutory limit, the Treasury Department cannot issue new debt to manage short-term cash flows or manage the annual deficit and the government may be unable to pay its bills.  

“But in the real world things are different,” said de Rugy. “The federal government has other options than to default.”

“If the debt ceiling is not increased, the Treasury can make interest and debt payments its first priority to avoid default, essentially putting the government on a stringent pay-as-you-go basis,” said de Rugy.

How likely is it that the debt ceiling will be raised?

“It will almost surely be raised,” said Veronique de Rugy. “It has become merely a symbolic cap, with Congress increasing the debt limit ten times in ten years, and raising it twice annually in 2008 and 2009.” 

Antony Davies agrees that the cap will be raised.

“The more likely scenario is that the debt-ceiling ‘crisis’ will be used for political grandstanding," Davies said. "Hopefully, responsible politicians will use this opportunity to strong-arm the irresponsible ones into accepting spending controls with serious teeth.”

What would a government shutdown look like?

Bruce Yandle, who was employed by the Federal Trade Commission during the shutdown 30 years ago, shares his perspective.

“When Congress chooses to cease funding government operations, federal agencies, by law, cannot function,” Yandle said. “A complete shutdown would end temporarily such things as protection of the president and congress, closing the FBI, ceasing protection of the food supply, agriculture commodity inspecting for export, and airport security, just to mention a few items.  By law, when the government shuts down, agencies must begin immediately to close shop, store records, and send sensitive materials to secure warehouses.  Shut downs are extremely costly.”

But a shutdown is unlikely, Yandle said. “Citizens tend to punish members of congress who engage in shutting down government, so legislators have a strong incentive to not let it happen,” he said.

How serious would a default be?

“Default would dramatically increase the interest rates for buying federal government’s bond. This would push up interest payments even higher, further exacerbating our spending problem,” said Matt Mitchell.

“Government would either face the prospect of not being able to borrow anymore (and thus issue a huge tax increase), or it would face the prospects of radical austerity to try to regain the trust of the bond market.”

Under either scenario, very dramatic spending reductions and very significant tax increases would be likely, he said.

“I think the bond market’s faith in the US would be shaken for quite a while.  As government would have to pay higher interest rates, it would have to compete with other borrowers such as private businesses and families, and all interest rates would go up,” Mitchell said.

 

An Opportunity or a Crisis?
February 11, 2011

With the United States rapidly approaching its debt ceiling, Mercatus Center scholars consider the possibility of surpassing it, and what that will mean for the economy.

Veronique de Rugy:

“The statutory debt limit was intended to control Congressional spending by limiting the amount of debt that the federal government could accumulate,” de Rugy said. “Today, we see that it is merely a symbolic cap, with Congress increasing the debt limit ten times in ten years, and raising it twice annually in 2008 and 2009.” 

De Rugy says that technically, if the debt nears its statutory limit, the Treasury Department cannot issue new debt to manage short-term cash flows or manage the annual deficit and the government may be unable to pay its bills.  “But in the real world things are different,” said de Rugy. “The federal government has other options than to default.”

“If the debt ceiling is not increased, the Treasury can make interest and debt payments its first priority to avoid default, essentially putting the government on a stringent pay-as-you-go basis,” said de Rugy.

With roughly 10 times more income than needed to honor our debt obligations, de Rugy says that the federal government will still have far more than enough money to fully service our debt. This year, for instance, about 6.5 percent of all projected federal government expenditures will go to interest on our debt, and tax revenue is projected to cover about 70 percent of all government expenditures.

De Rugy explains that our ability to stave off default depends not on our willingness to raise the debt ceiling, but on our continued commitment and ability to pay the interest on our debt. Unfortunately, as long as we continue to run deficits, the ability to borrow cheaply is key to avoiding default. 

“The United States is currently benefitting from extremely favorable borrowing conditions which are unprecedented.  That could change at any time and when that happens, it will be too late.”

Antony Davies:

There is a zero percent chance that Congress will not raise the debt ceiling, they’ve raised it more than 70 times over the past couple of decades, says economist Antony Davies.

“The more likely scenario is that the debt-ceiling “crisis” will be used for political grandstanding," he said. "Hopefully, responsible politicians will use this opportunity to strong-arm the irresponsible ones into accepting spending controls with serious teeth.”

There are three things that legislators can ask for in exchange for raising the debt-ceiling that will move us toward fiscal solvency, says Davies.

“Congress needs to impose a spending limit on all future budgets. By exchanging the debt ceiling for a spending ceiling, we take tax hikes off the table and focus attention on the source of the deficit problem: spending,” said Davies. “After a budget is passed, all discretionary spending allocations should be reduced by the same percentage so that total budgeted spending does not exceed 19 percent of the previous year’s GDP. This way, no single person has to take political heat for cutting specific programs since the cuts are automatic and across the board.”

We need to repeal the impoundment law requiring the President to spend money appropriated by Congress, says Davies.

“Without impoundment, Congress is the only entity that can control spending,” he said. “Impoundment, a power every President prior to Nixon had and which every President since Nixon has wanted, gives the President the power to control spending also.”

We don’t want to renege on promises made to current and near-current retirees; however, we need to get people off of Social Security without bankrupting the system for those who stay on it, says Davies.

“We need to control non-discretionary spending by allowing anyone who has paid Social Security taxes for at least 40 quarters to leave the Social Security system,” said Davies. “Upon leaving the Social Security retirement system, the person no longer pays Social Security taxes but also gives up all claims to future Social Security retirement benefits. Instead of Social Security, the employer will withhold the same percentage of the employee’s wages to be deposited in an approved private retirement account.”

 

Why Any Version of a BBA Is Doomed to Fail
David M. Primo
November 14, 2011

As required by the debt-limit deal, both chambers of Congress must soon consider a constitutional balanced budget amendment. But while debate in both the House and Senate has focused on which measure each will take up, it appears any version of a BBA is doomed to fail.

According to Mercatus Senior Scholar David Primo, the rejection likely will be the result of two primary causes: 1) Most members of Congress don't want spending rules they can’t break; and 2) those who oppose spending restraint have been effective in using critiques of specific proposals to paint all constitutional budget rules as suspect.

Primo said the following:

“With the nation’s dire fiscal situation, Washington’s apparent inability to address it, and polls consistently showing a solid majority of Americans in favor—it seems a constitutional balanced budget amendment should be a slam dunk. But even if both chambers took up an ideally crafted BBA, the measure almost certainly still would fail.

“The reason is likely two-fold.

“First, Congress tends to favor spending rules that sound tough, but that are written with plenty of loopholes and can easily be circumvented or simply waived. We’re just a few months out from the debt-limit crisis—and an historic downgrade by the S&P of U.S. debt—and already many in Congress are vigorously opposing, and suggesting how to stop, possible spending cuts that wouldn’t even happen until Fiscal Year 2013. This does not speak well to Congress’ s interest in real spending control.

“Second, those who oppose spending restraint have done a great job using critiques of specific proposals to paint all constitutional budget rules as suspect. Meanwhile, those who support strong balanced budget amendments have not been successful in dispelling those claims.

“If enough progress is made educating voters and policymakers about the need for well-designed, effective constitutional rules, I think we’ll see a much more honest debate on the merits of such rules—and a great deal more pressure from the electorate for Congress to send an amendment to the states for ratification.”

Primo, an associate professor of political science and business administration at the University of Rochester, has studied the budget process throughout his academic career and has authored research papers (such as “Making Budget Rules Work”) and an award-winning book on budget rules, Rules and Restraint: Government Spending and the Design of Institutions.


Transcript from Live Q&A on the Debt Ceiling
February 24, 2011

This transcript is from a live chat discussion between Mercatus scholars and members of the media regarding the debt ceiling.

 Debt Ceiling Q&A(02/24/2011) 
1:00
[Standby]  The host is placing this Live Event into Standby Mode.
1:44
Good afternoon. This is Catherine Behan from the Mercatus Center at George Mason University. I will be moderating this event. Our experts joining us and an idea of their thoughts are:

Veronique de Rugy, senior research fellow with the Spending and Budget Initiative at the Mercatus Center at George Mason University

“The federal government has other options than to default,” said de Rugy. “If the debt ceiling is not increased, the Treasury can make interest and debt payments its first priority to avoid default, essentially putting the government on a stringent pay-as-you-go basis.”

Matthew Mitchell, research fellow with the State and Local Policy Project at the Mercatus Center at George Mason University

“Default would dramatically increase the interest rates for buying federal government’s bond,” said Mitchell. “This would push up interest payments even higher, further exacerbating our spending problem.”

Garett Jones, member of the Mercatus Center’s Financial Markets Working Group and assistant professor of economics at George Mason University

“Republicans can’t realistically threaten to not raise the debt ceiling, because defaulting would mean we’d wouldn’t be able to borrow again at a low interest rate for services like national defense,” said Jones. “It’s a bluffing game.”

Antony Davies, Associate Professor of Economics at Duquesne University and member of the Spending and Budget Initiative at the Mercatus Center at George Mason University

“There are three things that legislators can ask for in exchange for raising the debt-ceiling: a spending limit on all future budgets, a repeal of the impoundment law requiring the President to spend money appropriated by Congress, and to control non-discretionary spending,” said Davies.

Bruce Yandle, Dean Emeritus of the Clemson College of Business and Behavioral Sciences and member of the Financial Markets Working Group at the Mercatus Center at George Mason University

“When Congress chooses to cease funding government operations, federal agencies, by law, cannot function,” Yandle said. “A complete shutdown would temporarily end such things as protection of the President and Congress, closing the FBI, ceasing protection of the food supply, and airport security, to name a few—they are extremely costly.”
Thursday February 24, 2011 1:44  
1:45
We are up early, but happy to store up some questions are we get things together
Thursday February 24, 2011 1:45  
2:01
[Comment From Guest Guest : ] 
Hi everyone I have a question: What will the implications of a shutdown be on the bond market (and therefore on borrowing costs)?
Thursday February 24, 2011 2:01 Guest
2:06
An answer is coming from Bruce Yandle, who is on the phone, not in the chat tool, and we're transcribing. I apologize for the delay.
Thursday February 24, 2011 2:06  
2:07
[Comment From Guest Guest : ] 
Will all federal employees be furloughed in the case of a shutdown?
Thursday February 24, 2011 2:07 Guest
2:09
[Comment From Bruce Yandle Bruce Yandle : ] 
If you look at the prices of credit default swaps as an indication of pending risk there is no meaningful evidence that the world credit market is indicating any nervousness about the possibility of default.
Thursday February 24, 2011 2:09 Bruce Yandle
2:10
[Comment From Matt Mitchell Matt Mitchell : ] 
Re. all employees being furloughed: no. the OMB requires agencies to have a contingency plan. Only non-essential employees will be furloughed.
Thursday February 24, 2011 2:10 Matt Mitchell
2:11
[Comment From Guest Guest : ] 
Why are Republicans going after federal workers and not cutting defense spending?
Thursday February 24, 2011 2:11 Guest
2:13
[Comment From Guest Guest : ] 
How would they expect the Defense Department to be treated in the event of a shutdown? Clearly, military folks in Iraq and Afghanistan would be exempted from furloughs, but how about civilian support staff handling clerical duties, etc.? Do they know how DOD was handled in the 1995-96 shutdowns?
Thursday February 24, 2011 2:13 Guest
2:16
[Comment From Matt Mitchell Matt Mitchell : ] 
Re. Reps and defense spending: If we want cuts to be meaningful, everything should be on the list, including defense spending. I can’t entirely speak to the political calculation that Republicans are making.
Thursday February 24, 2011 2:16 Matt Mitchell
2:16
[Comment From Veronique de Rugy Veronique de Rugy : ] 
I can't talk for Republicans' motives but to be fiscally responsible we need to put everything spending on the table, including defense spending
Thursday February 24, 2011 2:16 Veronique de Rugy
2:16
[Comment From Antony Davies Antony Davies : ] 
It's hard to talk about meaningful cuts unless we take nothing off the table. For example, the President recently spoke about cutting $300 million from community development block grants. That amount sounds large, but is truly irrelevant compared to the size of the deficit. In short, any cuts that don't include the word "trillion" aren't very meaningful.
Thursday February 24, 2011 2:16 Antony Davies
2:16
[Comment From Veronique de Rugy Veronique de Rugy : ] 
Re bond market: This question about the impact of the shutdown on bond market is the same we are getting about the impact of not raising the debt ceiling. Here is my take. Would the government’s change in policy to not raising the debt limit but instead cutting spending make the bond market nervous? Not raising the debt ceiling could change expectations about U.S. policy going forward, but the debt-limit debate has probably already caused investors to adjust their expectations about the United States’ long-term ability to pay back its debt.
Thursday February 24, 2011 2:16 Veronique de Rugy
2:17
[Comment From Veronique de Rugy Veronique de Rugy : ] 
Re bond market part 2: If government announces, however, that if and when the US debt reaches its ceiling, the government will prioritize spending and bondholders will get paid first, the policy change could trigger a virtuous cycle and a reduction in interest rates. Markets may react to a failure to raise the debt limit, but they could also react to an increase. When does the United States’ unwillingness to get its financial house in order becomes a liability that translates a hike in interest rates? Wouldn’t investors get nervous as they watch a country bury itself under yet more debt?
Thursday February 24, 2011 2:17 Veronique de Rugy
2:17
[Comment From Maximus Maximus : ] 
What will be the most likely outcome of this showdown? It seems there will have to be an immediate term agreement in light of the pending debt ceiling breach, and a long-term solution for dealing with the entitlements especially.
Thursday February 24, 2011 2:17 Maximus
2:19
[Comment From Antony Davies Antony Davies : ] 
Re: Maximus. A good outcome is that Congress replace the debt ceiling with a spending ceiling. The debt ceiling doesn't address the fundamental problem that the government has been spending beyond what it is capable of bringing in in revenue.
Thursday February 24, 2011 2:19 Antony Davies
2:20
[Comment From Guest Guest : ] 
Should we balance the budget in 5, 10, or 50 years should we cut $40 billion or $100 billion? What does success look like and why do cuts have to happen now?
Thursday February 24, 2011 2:20 Guest
2:21
[Comment From Antony Davies Antony Davies : ] 
Re: Guest. To balance the budget, we need to cut more than $1 trillion. The cuts proposed in the CAP Act have been called "irresponsible" by some politicians. But, even under these "draconian" cuts, we'd still end up with debt passing 100% of GDP within then next 5 to 10 years.
Thursday February 24, 2011 2:21 Antony Davies
2:22
[Comment From Bruce Yandle Bruce Yandle : ] 
Re DOD question from earlier: Each agency prepares a shutdown plan for OMB. The plan identifies critical personnel and activities that are essential for protecting life and enabling security for the nation. Presumably, DOD has no difficulty justifying continuation of all activities that relate to support of military and defense.
Thursday February 24, 2011 2:22 Bruce Yandle
2:23
[Comment From Matt Mitchell Matt Mitchell : ] 
Re. should we balance in 5, 10….Great question. If austerity requires cuts in too short a time frame, it may—paradoxically—create an incentive for politicians to simply abandon austerity. Yet, obviously, too long of a time frame isn’t effective. I’d say we need credible commitments to begin cutting right now, and achieve balance within 5-10 years.
Thursday February 24, 2011 2:23 Matt Mitchell
2:24
[Comment From Guest Guest : ] 
How long can we go under continuing resolutions before we would have to shut down?
Thursday February 24, 2011 2:24 Guest
2:24
[Comment From Guest Guest : ] 
Why not solve the problem with half spending cuts and half tax increases, isn’t this the kind of compromise we need?
Thursday February 24, 2011 2:24 Guest
2:25
[Comment From Antony Davies Antony Davies : ] 
Continuing from above...What we need to think about is not whether particular cuts are "too much" but rather where they leave us over the next 5 to 10 years. If bond markets start to get skittish as our debt passes 100% of GDP, the cost to the Federal government can be severe. For example, just a 1% increase in the interest rate the government has to pay on its debt translates into an additional $140 billion in spending each year.
Thursday February 24, 2011 2:25 Antony Davies
2:25
[Comment From Bruce Yandle Bruce Yandle : ] 
Re continuing resolutions: We can keep going on continuing resolutions indefinitely
Thursday February 24, 2011 2:25 Bruce Yandle
2:25
[Comment From Veronique de Rugy Veronique de Rugy : ] 
We should start addressing our debt problem today
Thursday February 24, 2011 2:25 Veronique de Rugy
2:26
[Comment From Antony Davies Antony Davies : ] 
Re: half tax/half cuts. Tax increases, historically, don't help. If you look at the past 50 years of data for the US, it doesn't matter whether tax rates are high or low. The Federal government's revenue has stayed constant at about 18% of GDP. What this means is that raising taxes will slow the economy and so the government will get 18% of a smaller pie.
Thursday February 24, 2011 2:26 Antony Davies
2:27
[Comment From Veronique de Rugy Veronique de Rugy : ] 
The debt crunch is driven mainly by the explosion in entitlement reform, so we must reform entitlement reform. However, we didn't get in this mess overnight and it will take some time to fix. Yet, we must start today.
Thursday February 24, 2011 2:27 Veronique de Rugy
2:27
[Comment From Antony Davies Antony Davies : ] 
Continuing...Again, looking at the historical data, revenue isn't the government's problem. It's revenue has been steadily rising -- even after adjusting for inflation and adjusting for population growth. The problem is that spending has been rising even faster.
Thursday February 24, 2011 2:27 Antony Davies
2:27
[Comment From Matt Mitchell Matt Mitchell : ] 
Re. ½ and ½: another great question. It certainly sounds reasonable, but it falls apart when you begin to analyze it. For one thing, if you look at projections, revenue is expected to bounce right back to historical levels (19% of GDP) within a few years. But spending will never return to normal. It will be 15 percentage points above normal by 2035.
Thursday February 24, 2011 2:27 Matt Mitchell
2:29
[Comment From Veronique de Rugy Veronique de Rugy : ] 
Why should we start today? The CBO released a study about the economic consequences of waiting to address the fiscal imbalance and the answer was: higher interest rates, less capital available for economic growth, few jobs, and lower incomes. Here is the link: http://cbo.gov/doc.cfm?index=11998&zzz=41460
Thursday February 24, 2011 2:29 Veronique de Rugy
2:29
[Comment From Bruce Yandle Bruce Yandle : ] 
Re outcome of this showdown: Here's my forecast: Another short continuing resolution will be passed next week to avoid government shutdown. After that, congress and the executive will come to grips partially with the deficit problem in light of Mr. Obama's budget proposal. Cuts will be made in out years for some entitlements. All along tactical games will be played with respect to raising the debt ceiling and adding continuing resolutions as needed. The U.S. will not default on debt.
Thursday February 24, 2011 2:29 Bruce Yandle
2:30
[Comment From Guest Guest : ] 
For federal workers, I believe they were all given back-pay after the last shutdown. There are rumors that this time around, any deal would not include back-pay for days not worked. This could be very financially painful for federal employees, who are in essence being temporarily furloughed against their will. Why should this sector of employees suffer from this political game, when in fact their pay has very little to do with the real problem of government spending?
Thursday February 24, 2011 2:30 Guest
2:31
[Comment From Matt Mitchell Matt Mitchell : ] 
More on ½ and ½ solution: remember, that debt and deficits are bad because they harm economic growth. But we also know that tax increases harm economic growth. So the cure may be worse than the disease. According to Romer and Romer, a 1 percentage point increase in taxes as a share of GDP tends to cause total GDP to be 3 percent smaller than otherwise.
Thursday February 24, 2011 2:31 Matt Mitchell
2:32
[Comment From Maximus Maximus : ] 
What is the "golden" debt-to-GDP ratio? Many economists say 60%. Perhaps it's 10, or 20,...50?
Thursday February 24, 2011 2:32 Maximus
2:32
[Comment From Veronique de Rugy Veronique de Rugy : ] 
Re: ½ and ½:. This is a great question. The problem about banking on tax revenue to address our problem is that it is not clear how much more revenue as a share of GDP the government can actually collect. historically, it hasn't been successful at collecting more than 19 percent in taxes as a share of GDP for more than a few years. Also, economists do agree that higher taxes have a negative impact on the economy, which reduces the GDP and hence reduces revenue. Also the problem is spending.
Thursday February 24, 2011 2:32 Veronique de Rugy
2:36
[Comment From Veronique de Rugy Veronique de Rugy : ] 
Re: What is the "golden" debt-to-GDP ratio? For a long time, economists have said that 60 percent as a share of GDP meant that we were entering a dangerous zone. It's true for most countries but not for all countries. For instance, Japan has had much higher debt ratio than that for a long time. However, most of their debt is due to domestic investors, which does seem to make a different. What we know for sure is that investors rate countries on a curve. So as long as our country looks as a saver investment than other countries we will be fine. Even with a high debt ratio than 60 percent. But no one knows how long that will last.
Thursday February 24, 2011 2:36 Veronique de Rugy
2:36
[Comment From Matt Mitchell Matt Mitchell : ] 
Re. golden: it is tough to say. The most-comprehensive studies suggest that going from 30 percent to 90 percent cuts growth rates in half. The problem is these studies are based on a wide sample of countries and the US is pretty unique. Our lenders are likely to give us more slack than they will others. But undoubtedly, we will not be able to sustain 200 percent, which is what it will be in just 25 years.
Thursday February 24, 2011 2:36 Matt Mitchell
2:36
[Comment From Antony Davies Antony Davies : ] 
Maximus: Good question. I don't know what the golden ratio is (or even if there is one). However, I'd caution you to include unfunded Medicare and Social Security obligations. These two animals don't appear in any of the debt figures, but (at least to some degree) they should be included. When the trust funds go broke, the government will be forced to do one of two things: (1) raise taxes to cover Medicare and SS obligations, or (2) default on the Medicare and SS obligations. In the first case, tax payers pay for the unfunded obligations. In the second case, retirees pay for the unfunded obligations. Either way, someone pays -- just as if the unfunded obligations were debt.
Thursday February 24, 2011 2:36 Antony Davies
2:36
[Comment From Otto Otto : ] 
Who is to blame if the shutdown occurs? Isn't this a sign of poor management i.e. the private-sector equivalent of not making payroll? Who's fault is it and why can't our politicians just work together to avert this disaster?
Thursday February 24, 2011 2:36 Otto
2:37
[Comment From Garett Jones Garett Jones : ] 
Re: bond market @2:01: A shutdown will probably be bad news. Just imagine how Greek bond markets would react if the Greek government couldn't agree on a budget and shut down--- it would sound like they didn't have their act together. With some pols pushing for troubled states to default, it's a reasonable worry.
Thursday February 24, 2011 2:37 Garett Jones
2:38
[Comment From Matt Mitchell Matt Mitchell : ] 
Re. “Isn’t this a sign of poor management?” Yes.
Thursday February 24, 2011 2:38 Matt Mitchell
2:39
[Comment From Antony Davies Antony Davies : ] 
From one perspective, it's not a matter of blame but of congratulations. By that, I mean that politicians have not taken our debt seriously enough for far too long. If a shutdown wakes them up to the severity of the debt problem, then perhaps some good will come from it. But I certainly hope they come to a more reasonable solution.
Thursday February 24, 2011 2:39 Antony Davies
2:39
[Comment From Veronique de Rugy Veronique de Rugy : ] 
re: Who is to blame if the shutdown occurs? I think both parties are responsible for the fiscal situation we find our self in. This problem didn't start with the election of Obama. It didn't start with the Democratic take over in 2006, it didn't start with Bush. But all are responsible for making a bad situation worse and by not address entitlement spending. We have known that it was not a sustainable path for a long time.
Thursday February 24, 2011 2:39 Veronique de Rugy
2:41
[Comment From Guest Guest : ] 
Some comments. The term for essential and non-essential federal employees have now been changed to "excepted" and "non-excepted." I am not sure that there will be a short-term CR passed, with incentives from the House moving in a very different direction from incentives in the Senate and the White House. The calculus is not the same as 1995. Entitlement spending has nothing to do with the shutdown since most of entitlements are not funded through discretionary appropriations. The shutdown also has nothing really to do with the debt celing debate, either. It will have almost no impact on the date when we reach the debt ceiling.
Thursday February 24, 2011 2:41 Guest
2:42
[Comment From Cynthia Cynthia : ] 
So, what do economists think we should trade for raising the debt ceiling -- since it's political suicide not to.
Thursday February 24, 2011 2:42 Cynthia
2:46
[Comment From Veronique de Rugy Veronique de Rugy : ] 
Is it a political suicide? Polls are showing that Americans do not want to see an increase in the debt ceiling. Here for instance, The Hill is reporting that a large share of the American public — 71 percent — opposes raising the federal debt limit. Moreover, the debate over the debt ceiling is really about a bigger problem.
Thursday February 24, 2011 2:46 Veronique de Rugy
2:47
[Comment From Antony Davies Antony Davies : ] 
2:42: We should trade two things: (1) a spending ceiling that is 18% of GDP, and (2) a repeal of the Impoundment Act so that the President can withhold dollars that Congress allocates. The first item has the greater short term impact. The second item has more of a longer term impact as it gives the President the power to close the spending purse.
Thursday February 24, 2011 2:47 Antony Davies
2:47
[Comment From Paul Paul : ] 
The GAO released a report about what the Treasury did previously when having to raise the debt ceiling...and the world did not fall apart. So what's the big deal?
Thursday February 24, 2011 2:47 Paul
2:47
[Comment From Garett Jones Garett Jones : ] 
Re: Otto. The Rodney King question is important: why can't we all just get along? But blame is the wrong way to analyze this: A firm can fail just because their product becomes unpopular---similarly, tax revenue typically collapses after a financial crisis. It's always tough to slice a smaller pie, so these fights are natural.
Thursday February 24, 2011 2:47 Garett Jones
2:49
[Comment From Antony Davies Antony Davies : ] 
Paul: The debt ceiling has been raised 70+ times since the 1970s. This suggests that the debt ceiling is purely a fiction. A ceiling isn't a ceiling if Congress can lift it whenever it gets close.
Thursday February 24, 2011 2:49 Antony Davies
2:49
[Comment From Bruce Yandle Bruce Yandle : ] 
Re golden debt: Evidence that deficits affect GDP growth adversely is associated with a 60% ratio. At that point, GDP growth is affected to the point that it is difficult to service the debt and continue normal government operations.
Thursday February 24, 2011 2:49 Bruce Yandle
2:50
All, we have 10 more minutes and would like to get as many questions in as possible. Please submit any more questions and we'll make sure the scholars get the chance to respond!
Thursday February 24, 2011 2:50  
2:51
[Comment From Bruce Yandle Bruce Yandle : ] 
Re federal workers' suffering: Workers are being furloughed nationwide due to budget shortfalls; these include teachers, healthcare workers, as well as workers in the private sector. But those furloughs are done deliberately with notice to those affected. Federal workers deserve the same treatment. They should be given notice of shortfalls and then be informed of the duration of the furlough. Furloughs are tough, but these are tough times.
Thursday February 24, 2011 2:51 Bruce Yandle
2:51
[Comment From Veronique de Rugy Veronique de Rugy : ] 
I am not sure what economists would argue is the right thing to ask for in exchange for an increase in the debt ceiling but I am thinking that at the very least we would like to see a serious commitment to curbing the explosion in entitlement spending. Also, I think we really should think about the consequences of raising the debt ceiling. It is not a risk free event.
Thursday February 24, 2011 2:51 Veronique de Rugy
2:51
Veronique, how is it risky, to amplify the guest's question
Thursday February 24, 2011 2:51  
2:52
[Comment From Bruce Yandle Bruce Yandle : ] 
Re debt ceiling: Since 2002, the debt ceiling has been raised each year, twice in 2008. And each year, the deficit has grown larger. This is "bullet-biting time." We must find the resolve to cut spending, broaden the tax base, cut marginal tax rates, and get the deficit on a negative growth path. This should be done in conjunction with raising the debt ceiling.
Thursday February 24, 2011 2:52 Bruce Yandle
2:54
[Comment From Veronique de Rugy Veronique de Rugy : ] 
Paul: The debt ceiling was raised 10 times in the last 10 years, some years more than once. The debt limit is a very poor budget constraint. First and foremost, it does not alter the spending and revenue policies that determine debt and deficits. But we also need to remember that raising the debt cap is only a symptom, not the cause, of the bigger problem: the endless appetite of the federal government for spending taxpayers’ dollars.
Thursday February 24, 2011 2:54 Veronique de Rugy
2:54
[Comment From Veronique de Rugy Veronique de Rugy : ] 
Think about it this way, if you want to lose weight, the only solution is to stop eating. Just telling yourself that you can’t gain an additional 30 pounds this year won’t help. In fact, it will make things worse. Identically, Congress should stop spending money instead of ruling that it should increase the debt by some hundred of billions of dollars this time around.
Thursday February 24, 2011 2:54 Veronique de Rugy
2:55
[Comment From Guest Guest : ] 
How do we solve this larger problem? We've raised the debt ceiling a dozen times, aren't we just going to have to do it again? Is there a way to break the cycle?
Thursday February 24, 2011 2:55 Guest
2:56
[Comment From Bruce Yandle Bruce Yandle : ] 
Re Guest some comments: Good points and agreed. Since 1977 there have been 12 or so government shutdowns, usually for one to three days. 1995 is the outlier, in terms of length and related public outcry. A shutdown for a few days will not likely generate a huge outcry, and allowing a shutdown, as you suggest, has little to do with the larger deficit question and the possibility of default.
Thursday February 24, 2011 2:56 Bruce Yandle
2:56
[Comment From Antony Davies Antony Davies : ] 
Guest: There is only one way to break the cycle: stop spending so much. For example, if we took 2004 Federal spending and grew it to account for inflation and then grew it again to account for population growth, we'd have a balanced budget this year.
Thursday February 24, 2011 2:56 Antony Davies
2:57
I'll ask what others might, Ant: why can't we break the cycle by spending less AND raising taxes?
Thursday February 24, 2011 2:57  
2:57
[Comment From Veronique de Rugy Veronique de Rugy : ] 
To break the circle we have to implement strict budget rules that prevent Congress from spending endlessly. We need to reform entitlement spending, it is key to our long-term situation.
Thursday February 24, 2011 2:57 Veronique de Rugy
2:58
[Comment From Garett Jones Garett Jones : ] 
2:42:There's nothing to 'trade' in exchange for raising the debt ceiling--- it's going to happen. Precisely because it's must-pass, pols want to get their hard-to-pass issues onto the debt ceiling bill. Issues that a slim majority grudgingly support---that's what you put onto the debt ceiling bill.
Thursday February 24, 2011 2:58 Garett Jones
2:58
[Comment From Veronique de Rugy Veronique de Rugy : ] 
Also, it is important to separate the facts from reality. It wouldn't be hard to balance the budget by 2020. As Nick Gillespie and I have shown in this piece, http://reason.com/archives/2011/02/14/the-19-percent-solution, ll it takes, it a reduction is the growth rate of spending.
Thursday February 24, 2011 2:58 Veronique de Rugy
2:59
[Comment From Antony Davies Antony Davies : ] 
No, even if raising taxes helped (which, history suggests it doesn't), raising taxes only hides the problem. The problem isn't revenue. The problem is spending. To extend Veronique's analogy, buying bigger pants doesn't solve a weight problem. The only thing that solves the weight problem is to eat less and move more.
Thursday February 24, 2011 2:59 Antony Davies
3:00
[Comment From Matt Mitchell Matt Mitchell : ] 
Re. 2:55: there is a precedent for breaking the cycle. Harvard’s Alesina has analyzed the experience of other countries and found that spending reductions are more effective than tax increases. Moreover, we can look to examples such as Canada where 6 dollars in cuts for every 1 dollar in tax increases really did work. More here: http://neighborhoodeffects.mercatus.org/2010/11/15/can-a-reduction-in-government-spending-stimulate-the-economy/
Thursday February 24, 2011 3:00 Matt Mitchell
3:00
[Comment From Veronique de Rugy Veronique de Rugy : ] 
However, balancing the budget without reforming entitlement would balance the budget and maybe send the signal to our investors that we are serious about our budget problems, but it would only be balanced for a few years.
Thursday February 24, 2011 3:00 Veronique de Rugy
3:00
[Comment From Garett Jones Garett Jones : ] 
Remember this as long as pols aren't self-destructive, the debt ceiling is a sideshow--- the real issue is the collapse in post crisis tax revenue and entitlements.
Thursday February 24, 2011 3:00 Garett Jones
3:02
[Comment From Veronique de Rugy Veronique de Rugy : ] 
By the way, it is important to remember not reforming entitlements today will lead to a reduction in benefits in the future. Take Social Security, for instance. By refusing to reform Social Security, we are guaranteeing automatic benefit cuts of about 22 percent for everyone on the program in 2037 (when the trust funds are theoretically projected to run dry) without having had retirees plan for a replacement income.
Thursday February 24, 2011 3:02 Veronique de Rugy
3:02
OK, we're at the top of the hour! I really appreciate everyone's participation. This chat will be posted on the web for the future at mercatus.org/newsroom. If you have further questions for scholars, please contact me at cbehan1@gmu.edu or Annie Dwyer at adwyer2@gmu.edu.
Thursday February 24, 2011 3:02  
3:02
 

 
 

A Fair Tax Code Won't Help to Close the Deficit
Bruce Yandle
July 28, 2011

As Washington scrambles to find the “just right” package that will allow enough of Congress to vote for an increase in the debt ceiling, some leaders have asked those Americans who make more money to be willing to pay more taxes, calling for fairness to be reflected in the tax code. However, new research from Bruce Yandle finds that from 1979 to 2007 the individual income tax burden on the top 1 percent of the population has more than doubled while some 40 percent of U.S. taxpayers pay no income taxes at all.

“The fairness argument is largely political,” said Yandle. “The majority of people aren’t rich, so the majority of voters aren’t rich. But while the fairness is an important issue and one that must be addressed by wise politicians, it doesn’t get you very far in looking for more revenues and lower spending.”

Yandle says that attempting to make a fair tax code doesn’t help to close the deficit. “Raising taxes on the rich doesn’t necessarily generate more revenue,” he said. “Wealthy investors have too many ways to escape. With higher tax rates, less investment will follow, and more will be spent in finding ways to avoid taxes. If the goal is more revenue, then tax rates should be reduced and loopholes closed.”

“If the U.S. is to get its fiscal house in order, the tax laws will have to be changed to broaden the base, just as President Obama’s deficit reduction commission has argued,” said Yandle.

 

How the United States Can Avoid Default?
Veronique de Rugy
July 12, 2011

Many scenarios are being discussed as to what will happen if the United States does not raise the debt ceiling by August 2. Economist Veronique de Rugy explains why she believes one such scenario is being inaccurately credited to Standard and Poor's (S&P).

“Many attribute S&P with warning the U.S. government that its rating would be downgraded to ‘D’ if Treasury fails to pay any of its bills. That is not my understanding of what S&P actually said,” said de Rugy, a senior research fellow at the Mercatus Center at George Mason University.

“Technical default would occur only if Treasury fails to pay interest on the debt,” she said. “Thus, we would see a downgrade in our ratings if debt payments, not any payments, were missed.”

“There are short-term financial management options Treasury can use to avoid a U.S. default—which is the most important thing to do—at least through the end of the fiscal year, if not longer,” said de Rugy. “None of the options are particularly attractive, but any is better than default.”

 

How the U.S. Debt Problem Magnifies Unemployment
Matthew Mitchell
August 5, 2011

This week, Treasury reported that raising the debt ceiling caused gross U.S. debt to reach 100 percent of GDP. An even more telling measure, our “net debt,” stands at 67 percent of GDP, not 100 percent, said Mercatus Center economist Matt Mitchell. But the CBO projects net debt will reach 100 percent of GDP within 10 years. 

“This is worrisome because the best economic studies show that a nation’s economic growth tends to be cut in half when its debt-to-GDP ratio exceeds 90 percent,” said Mitchell.

It would be nearly impossible to fix our unemployment problem if the economy’s growth rate were hobbled by that level of debt, he said.

“Less economic growth exacerbates the jobs problem,” said Mitchell. “It means lower wages, fewer opportunities, and an overall lower standard of living.”

Some people are worried that austerity will harm the economy, he said, but there is never a ‘good’ time for austerity and necessary cuts will only get larger and more painful the longer we put them off.

“Austerity is not a slam dunk, but researchers have found that spending cuts are less likely to harm the economy than revenue increases,” said Mitchell. “The likelihood of austerity boosting the economy is just as good as stimulus measures, like infrastructure spending. But, it doesn’t add to our debt.”

 

 Reducing Size of Government Will Reduce Debt
Veronique de Rugy
January 13, 2012

The president’s proposal to combine several trade and commerce agencies may not save large numbers in spending, but it is still a step in the right direction, says Mercatus Center Senior Research Fellow Veronique de Rugy.

“By reducing the size of government, the president is taking small step to cut spending and reduce our debt problem,” said de Rugy. “By eliminating redundancy and waste through the agencies, we’ll reduce our debt-to-GDP ratio, which reached an unprecedented 100 percent this week.”

“What we need is to get rid of all the duplicative programs in the federal government. Unfortunately, the president’s proposal only scratches the surface,” said de Rugy. “Reducing the size of the economic pie that the government holds usually allows room for the private sector to expand. This helps generate economic growth and jobs that we desperately need right now.”

 

Debt-limit Debate: Losing Sight of Why It Matters
Veronique de Rugy
July 20, 2011

The debt-limit debate is in its eleventh hour, and with all the political maneuvering, economist Veronique de Rugy worries that we are losing sight of the only reason why the fight matters. It forces a discussion of the country’s real problem — unrestrained government spending and the tremendous fiscal imbalances that jeopardize our financial safety, she says.

To avoid being downgraded, the U.S. must actually put a plan into place, said de Rugy, a scholar at the Mercatus Center at George Mason University.

“The door is left open for raising the debt ceiling without a deal, but not without conditions,” she said. “The negotiations leading to the debt-ceiling increase have to make it clear that a $4 trillion deal is coming within the next three months.”

“Ultimately, the only way to avoid the potential negative consequences that come with a downgrade, a default, or an increase in the debt ceiling without a deal,” said de Rugy, “is to commit to addressing our long-term fiscal issues within the next few months by cut spending significantly, pass real institutional reforms to lock in the spending cuts, and engage in fundamental tax reform.”

For more on the debt-ceiling debate, see de Rugy’s latest post at National Review Online: The Real S&P Warning: A $4 Trillion Deal or a Downgrade.

 

What Makes a Debt Deal Successful?
Matthew Mitchell
August 1, 2011

As hours tick away for Congress to pass a debt-ceiling bill, a downgrade threatens to push interest rates higher, making it more difficult for consumers to borrow, for businesses to hire, and for the economy to grow, says Mercatus scholar Matt Mitchell.

Standard & Poor’s has already warned that a downgrade is imminent without a “credible solution,” one they recommend should include $4 trillion in spending cuts and/or revenue increases. But, what does the right combination look like?

“Examining 37 years of data from 21 nations, economists Alberto Alesina and Silvia Ardagna identified 107 separate efforts to get debt levels under control,” said Mitchell. “They found that, not only does a successful fiscal reform seem to require significant spending reductions, it also tends to occur when revenue is reduced.”

Some people worry that aggressive spending reductions will harm the economy, says Mitchell.

“But what the researchers actually found was that spending cuts were less likely to harm the economy than revenue increases,” he said.

For more information check out Mitchell’s The Real Debt Crisis: What Can Be Done? and his blog posts at Neighborhood Effects.

 

Can Your iPhone Fix the Debt Ceiling Mess?
Jerry Brito
July 29, 2011

Congressional leaders have turned to iPhones, iPads, and smartphones as a possible source of revenue. As providers like Verizon and AT&T are about to face a spectrum crunch, broadcast television has additional spectrum that remains underutilized.

“The obvious answer is to move that spectrum from TV to mobile broadband, but it's not that easy.” Brito explained.

“Congress has to give the FCC authority to hold the auctions and share the revenue with broadcasters. What they're more interested in, however, is the part of the auction revenues that isn't shared,” Brito said. “That goes straight to the federal government thus generating much needed revenue without raising taxes—something upon which both Democrats and Republicans can agree.”

“Mobile broadband providers get more spectrum, TV broadcasters get compensated, Congress gets revenue for the deficit, and consumers get a better wireless experience and don't have to miss their favorite TV shows” he said. “Thanks perhaps to the iPhone, there's a rare silver lining in an otherwise cloudy outlook.”

 

Debt Ceiling Debate Isn't Without Choices
Steven Horowitz
June 15, 2011

Ben Bernanke is urging Congress to keep the debt ceiling vote separate from spending cut debates, but economist Steven Horwitz says that even if Congress is unable to pass the debt ceiling by the August deadline, Congress can choose to prioritize the incoming tax revenue to avoid default.

“People imagine a doomsday scenario where we’ve maxed out the credit card and have nothing in the bank account, when in reality we have plenty of tax revenues to pay off interest on our debt and continue payments for programs like Social Security,” said Horwitz.  

“If you don’t pay your mortgage, but you buy a new TV, that’s a choice you’ve made,” said Horwitz.  “If we don’t raise the debt ceiling, we’ll have to make tough choices on spending, but the point is that there are tough choices available to be made.”  

Horwitz says that while there are ways to ensure that bond holders are paid even if the debt ceiling isn’t raised, the borrowing limit could impact the tools Bernanke has to try to stimulate the economy.

“If the United States isn’t able to issue more debt, it will be harder for Bernanke to increase the money supply through bond purchases, as there will be no additional bonds coming to the market,” said Horwitz. “There are implications for the Federal Reserve if the debt ceiling isn’t increased.”

 

Debt Ceiling is a Distraction from the Long-term Challenges
David M. Primo
June 23, 2011

With Eric Cantor walking away from Vice President Biden’s budget talks, the debate around deficit reduction has stalled. Mercatus Center scholar David Primo says that the debt ceiling debate ought to be decoupled from discussions over government spending, as fights over the debt ceiling are a distraction from the long-term fiscal challenges we face.
 
“Trading a short-term debt ceiling increase today for some spending cuts today is—all else equal—a good idea, but I think the negotiations on the debt ceiling and cuts to this year's budget are like haggling over how much to pay for a lamp at a garage sale while your house is about to go into foreclosure,” said Primo.
 
Primo says that the way to achieve a long-term agreement that binds future Congresses and presidents to implement real reforms is a constitutional rule that limits the ability of government to spend. He says that this will create the framework for debates about what the priorities of the federal government should be.
 
“The view of Democrats that we don't need to worry about long-term fiscal threats because the economy is doing poorly is wrong. The view of Republicans that we need to go to the mat for trivial spending cuts today is wrong. The view that we just need a plan today for cuts tomorrow is wrong. Unlike private individuals, legislators can't write contracts binding them in the future,” said Primo. 

 

The Cause of the Debt, not Hitting the Ceiling, is the True Worry
Jason J. Fichtner
May 4, 2011

Despite the claims in Secretary Geithner’s warning to Congress of defaulting in August unless the debt ceiling is raised, Mercatus Center economist Jason Fichtner says the United States has enough expected cash flow from tax revenue and assets to avoid defaulting until at least the end of the current fiscal year in September, perhaps even longer.   

“The debt-ceiling is the wrong debate, and it’s keeping us from focusing on the underlying problem, which is the government spending that got us here. There are several ways to deal with this problem and what’s important is for the United States to implement institutional reforms that restrict government spending and return it to a sustainable fiscal position,” said Fichtner.  “Reforms could include annual real spending caps and ending the abuse of the emergency spending rule.”

“According to the CBO, the federal government is estimated to collect $2.2 trillion in tax revenue over fiscal year 2011. That alone would be enough to cover interest on the debt - approximately $214 billion - and avoid any technical default of the U.S. government,” said Fichtner. 

Fichtner says that with the revenue government collects, the United States can pay the interest on the debt and still cover Social Security ($727 billion), Medicare ($572 billion), and Medicaid ($274 billion) with approximately $400 billion still remaining for other priorities.  The rhetoric around the debt ceiling debate is masking the true problem that government spending needs to be reduced.

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