By James C. Capretta
James C. Capretta holds the Milton Friedman chair at the American Enterprise Institute.
The US federal government has a major debt problem, but the solution is not the current statutory limit on government borrowing, which is counterproductive and could inadvertently cause permanent damage to the US economy. The limitation should be scrapped immediately and replaced with a less risky budget process, one that encourages political leaders to focus on long-term deficit reduction.
Pushing up against the limit
Last September, President Trump and Congress agreed to suspend the current limit on the federal debt—set at $19.8 trillion—through to December 8, 2017. Congress has not acted to raise the debt limit since it was re-imposed late last year, but Treasury Secretary Steven Mnuchin has been able to get around this by using so-called ‘extraordinary measures’. Those measures include holding back on the crediting of investment balances to government-owned accounts in order to limit the amount of implicit government debt that counts against the limit.
Notwithstanding these extraordinary measures, the Congressional Budget Office (CBO) now expects that the federal government will be unable to pay all of its bills and stay below the current borrowing limit starting sometime in the first half of March. Congress and the Trump administration should use this crisis to get rid of the debt limit once and for all.
A danger to the country’s financial solvency
Placing a limit on federal borrowing is dangerous. Risks squander one of the United States’ most important economic assets. The US is the world’s safest place to invest, and Treasury securities are the world’s safest investments. When individuals, companies, pension funds, or foreign governments want to place some of their capital in risk-free instruments, more often than not they buy bonds issued by the US government. The perception that US Treasury securities are near-riskless investments allows the federal government to borrow funds at preferential interest rates compared to the private sector.
However, a single political miscalculation could be enough to squander this valuable economic advantage. The current debt limit creates the risk that a political standoff in Washington could lead the federal government to miss a payment on outstanding debt or delay required payments to federal contractors or program beneficiaries. Anyone of these would seriously harm the reputation of the US government.
It makes no economic sense for a country as rich as the US to create this risk for itself. The US has the highest GDP per capita of any country in the world. The government’s growing debt is a major problem but the country’s wealth is so vast that there is no real prospect of societal insolvency as there is in some other countries.
A Danish comparison
There are only two countries in the world with advanced economies that have effective limits on government borrowing: The US and Denmark. Unlike the US, Denmark’s limit has been set so high that there is no real prospect of ever reaching it. Thus, the US is the only rich country in the world that chooses to elevate its risk of default by limiting the ability of its government to borrow in public markets.
True, the US has always had a debt limit, but it has only become a real risk to the economy in recent years. For most of the country’s history, the federal government was small and decentralised. Congress placed limits on borrowing by specifying the uses for borrowed funds and the kinds of bonds that were to be issued by the Treasury. As the federal government grew early in the last century, Congress gradually moved toward today’s system of placing an overall limit on total federal borrowing, leaving the Treasury Department with significant latitude to decide the mix of securities it issued.
Although Congress has always limited federal borrowing, there used to be a widespread understanding among politicians that it would be a catastrophic error to ever default on the debt. And so there was an expectation that the limitation would be raised when it was necessary to do so; it was only a matter of when and how much. No one feared a default because no one wanted a default.
The current challenge of political polarisation
That is still the case today for the most part. However, there are reasons to worry that a default could occur by accident. The deep polarisation that has infected the nation’s politics could inadvertently trigger a crisis. Members of the House and Senate dislike nothing more than to vote for more government borrowing. There are many Republican members of Congress who refuse to vote to raise the debt limit under any realistic political scenarios.
Furthermore, there are signs that factions in Congress are becoming more willing to use brinkmanship with the debt limit to gain political leverage. Some members are willing to hold back their votes on raising the debt limit and risk default in order to force their political opponents to give ground in a negotiation. The danger is that this kind of brinkmanship will get out of control and Congress will not be able to raise the debt limit in a timely fashion, thus triggering a default.
An obvious solution
There is no reason to take that risk. Congress should abandon the debt limit for good and replace it with new procedures aimed at facilitating long-term deficit reduction. There are many possible alternatives. Congress could, for example, establish a target for maximum debt, and then create expedited procedures for considering proposals to keep debt below that target. Congress could also call for more independent expert assessments about the size and scope of the problem and how to fix it.
The debt limit has not worked as a mechanism for encouraging fiscal discipline. Instead, it has created a growing risk that a political miscalculation will give investors a reason to question the financial stability of the United States government. It is long past time to scrap it.
Featured Image Source: Flickr
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