The federal government has a major debt problem, but the solution is not the current statutory limitation on government borrowing, which is counterproductive and could inadvertently cause permanent damage to the U.S. economy. The limitation should be scrapped immediately and replaced with a less risky modification to the budget process, one that encourages political leaders to focus on long-term deficit reduction.
Last September, President Trump and Congress agreed to suspend the current limitation on federal debt — set at $19.8 trillion — through 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 it 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 the federal government will be unable to both 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 the need to address the debt limit in the coming weeks as an opportunity to get rid of it once and for all.
Placing a limit on federal borrowing is dangerous and risks squandering one of the United States’ most important economic assets. The U.S. 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 U.S. government. The perception that U.S. treasury securities are near riskless investments allows the federal government to borrow funds at preferential interest rates compared to the private sector and to governments with records of financial mismanagement.
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. Any one of these would seriously harm the reputation of the U.S. government.
It makes no economic sense for a country as rich as the U.S. to create this risk for itself. The U.S. 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 that there is no real prospect of societal insolvency (as there is in some other countries, such as Greece).
It says something that there are only two countries in the world with advanced economies that have effective limits on government borrowing: the U.S. and Denmark. Unlike the U.S., Denmark’s limit has been set so high that there is no real prospect of ever reaching it. Thus, the U.S. is the only rich country in the world that chooses to elevate its risk of default by limiting the ability of the government to borrow in public markets.
True, the U.S. 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 decentralized. 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.
That’s still the case today, for the most part. But there are reasons to worry that a default could occur by accident. The deep polarization 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 leverage. Some members are willing to hold back their votes on raising the debt limit, thus risking 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 won’t be able to raise the debt limit in a timely fashion, thus triggering a default.
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 — the objective of sound fiscal policy. 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 full faith and credit of the United States government. It is long past time to scrap it.
James C. Capretta is a RealClearPolicy Contributor and holds the Milton Friedman chair at the American Enterprise Institute.