The Looming Debt Limit Crisis

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After thirty years of rising income and wealth inequality and federal debt, and declining prosperity, the U.S. is now poised on the brink of an economic disaster.  The legal limit on the amount of debt the federal government can raise, the “debt ceiling” of $14.294 trillion, was reached on May 16, 2011.  The Treasury Department immediately stopped issuing and reinvesting government securities in certain government pension plans, commencing “a series of steps designed to delay a default until August  2.” [1] For the United States to default on its debt, for the first time ever, would have grave consequences for an American economy already reeling from the worst recession since the Great Depression, and for the global economy as well.  As in the past, that possibility can be avoided by Congress raising the limit, but Congress is threatening not to do so.

Here is the situation as explained by the Congressional Research Service (CRS):

“Under current estimates, the federal government will have to issue an additional $738 billion in debt above the current statutory limit to finance obligations for the second half of FY2011. If the debt limit is reached and Treasury is no longer able to issue federal debt, federal spending would have to be decreased or federal revenues would have to be increased by a corresponding amount to cover the gap in what cannot be borrowed. To put this into context, the federal government would have to eliminate all spending on discretionary programs, cut nearly 70% of outlays for mandatory programs, increase revenue collection by nearly two-thirds, or take some combination of those actions in the second half of FY2011 (April through September 30, 2011) in order to avoid increasing the debt limit. Additional spending cuts and/or revenue increases would be required, under current policy, in FY2012 and beyond to avoid increasing the debt limit.”  [2]

Effects of a Default

No one can confidently predict how bad the situation would be if the debt limit is exceeded.  Interest rates would rise because holding federal debt becomes riskier, and inflationary pressure should increase as the value of the dollar falls.  And because federal spending requires borrowing in a deficit situation, government spending must also be curtailed.

Here are some of the potential worst-case consequences of a default, as summarized by Nathan Hurst for the Detroit News:

  • Americans would feel the impact of not raising the debt ceiling through higher mortgage rates, lost jobs, lower business exports and a cutoff of money for federal programs;
  •  The nascent national economic recovery, which is beginning to add jobs, would grind to a halt.  If the economy grinds to a halt, that will have implications worldwide, threatening to dry up export markets;
  • Interest rates on loans and credit cards would likely rise since the federal government would be paying more on its own debt, throwing credit markets into turmoil. Creditors could demand higher interest rates from the federal government, if they decided to continue lending the United States money at all;
  • Mortgage and other loan markets would gyrate wildly, dragging down the real estate and stock markets;
  • Thousands of businesses struggling to get back on their feet from the economic downturn could get a second shock, too, since the market disruptions would interrupt lines of credit;
  • Pension group fund investments would be hit hard. * * * If [retirement system assets] lose value, the amount the pension fund can pay out to recipients could be in jeopardy;
  • Pension funds and other retirement accounts could see another deep dip in value, potentially one worse than the market’s 2007 and 2008 lows, * * * ruining nest eggs for soon-to-be retirees and for those already retired. [3]

Citing Nate Silver’s analysis for the a New York Times article, Ryan Witt also argues further that consequences would be long-term and difficult to reverse:  “[O]nce the damage is done to the United States economy and/or credit rating it will be impossible to reverse.  A government shutdown is bad for the economy, but the effects are relatively easy to overcome once the government restarts.  If the economy or United States credit rating starts to nosedive because of a potential default the problems will not simply go away once Congress raises the debt limit.  The consequences will be long-lasting and take years, if not decades, to overcome.  As Silver puts it, ‘another severe recession would probably be about the best-case scenario’ if the United States were actually to go into default.”  [4]

Any further damage to the economy as described above would ensure declining federal revenues and even greater budget problems in future years.  Moreover, rising interest rates would increase the cost of existing federal debt, further exacerbating budget deficits: “The Congressional Budget Office estimates that adding a point to interest rates on the federal debt increases the deficit over the next 10 years by $1.3 trillion. That one point could easily be three or five or six points — nobody knows. But leave it at one, surely the most optimistic scenario.  This means that a significant number of ‘fiscally responsible’ Americans are supporting action that would increase the debt by an amount at least equal to the entire $1.3 trillion 2010 deficit.” [5]

The Risk of a Default

As noted, the United States has never defaulted on its debt.  Over the past 30 years, as the federal debt increased the debt limit was frequently reached, and Congress always increased it as a matter of course.  Congressional Republicans are now threatening, however, not to approve an increase if they do not get their way in the budget negotiations:

“[A] look back in history shows the GOP was not always so demanding.  …  The debt limit was increased by over $4 trillion during the Bush years, and the Republicans required no offsetting spending cuts or tax increases in order to raise the debt ceiling.  The current ‘big four’ Republicans leaders (Speaker John Boehner, House Majority Leader Eric Cantor, Senate Minority Leader Mitch McConnell, and Senate Minority Whip Jon Ky) all voted ‘yea’ for well over $3 trillion in debt limit increases without any demands for spending cuts.” [6]  In fact, “of the 7 debt limit bills passed under the Bush Ad­min­is­tra­tion, an av­er­age of 39 Re­pub­li­cans voted in favor.” [7]

Why would Republicans suddenly “play chicken” with the economy and American prosperity now, after never having done so before?  Even as a bluff this seems especially  irresponsible for politicians who continue to insist they are for economic recovery and job creation (as they promised in 2010 election campaigns).  To understand what is going on now, we need to understand how we got into this situation.

How We Got Here

In 1980, the federal debt of about $994 billion was 32.5% of annual Gross Domestic Product (GDP).  It rose steeply during the Ronald Reagan/George H.W. Bush years to 66.1%, declined slightly during the Clinton years, and then rose from 56.4% to nearly 84.3% of GDP during the GW Bush years. [8] The following graph shows debt as a percentage of GDP from 1941 to today. [9]

Ominously, today’s $14.3 trillion debt may grow to 100% of GDP this year, for the first time since WW II. [10]

As we have explained, the rise in federal debt federal debt over the last 30 years has been the consequence of policies favoring wealthy people and the corporations they control in the so-called “Reagan Revolution.”  Through substantially lower taxes on capital gains, corporate earnings, and income taxes at the top income tax rate,  together with decreased regulation of banking and corporations leading to vastly higher profits, the wealthiest 1% of Americans has greatly increased its percentage of total incomes  and wealth.  The value of the increased percentage of total wealth held by the top 1% over these years is about $10 trillion. (Meanwhile, the bottom 99% and the declining middle class did not gain wealth, and actually lost more than $5 trillion through the loss of home values after the housing market crash in 2008.) Government spending was not reduced to reflect the lower taxes that enabled the top 1% to amass more wealth.

Instead, as shown on the graph, the Republican administrations ran up what now totals (including compounding interest) more than $12.2 trillion of the federal debt.  In effect, wealthy people and corporations used the borrowing power of the United States to finance their increased incomes and wealth.  The consequences of these thirty years of increased inequality are important to understanding today’s situation.

The Economic Implications

As noted, federal debt is reaching 100% of GDP for the first time since WW II.  Today’s situation, however, is far more precarious than that existing after WWII.  Back then, the wealthiest Americans and corporations were paying taxes at much higher rates.  Consequently, GDP growth was relatively strong, America prospered, and debt as a percentage of GDP was falling over time.  Today, however, just the reverse is true:  (1) Incomes of the wealthy and corporations have been taxed at much lower effective rates, so their contribution to growth and responsibility for debt management continues to lag;  (2) Economic growth has declined over 30 years of growing inequality of incomes and wealth, and in the Great Recession following the housing bubble crash in 2008, the economy has been stagnant; (3) High unemployment and lower wages have reduced tax revenues from the bottom 99%, and the spending cuts Republicans insist on making would reduce jobs even more, worsening future deficits and causing substantial further increases in debt.

This would be untenable, especially with the current deficit well over $1 trillion.  In 2010, federal spending totaled about $3.5 trillion, [11] and in 2011, federal spending is expected to rise to $3.8 trillion [12], to be financed by about $2.17 trillion of direct revenue and an estimated deficit of $1.65 trillion. [13] A big part of the accelerating deficit problem is growing interest on the already enormous debt: the federal government paid about $80 billion in debt interest over the first four months of fiscal 2011, so the government will have to borrow about $250 billion in 2011 to pay interest on the current debt. [14]

It should be clear to everyone that the only way out of this mess is to increase tax revenues while avoiding spending cuts that reduce economic stimulus.  It should also be apparent that with such a huge deficit, and the total debt continuing to grow so rapidly, this is an unimaginably bad time to contemplate defaulting on the federal debt and not raising the debt limit.

The Political Implications

To begin, with the wealthy 1% and their corporations having amassed boundless fortunes, while running up $12.3 trillion of today’s outstanding federal debt in the process and driving the active, “lower” economy into a recession, it should be extremely galling to all other Americans to hear them argue that social programs – essentially all government spending which does not significantly contribute to corporate profits and their own wealth – are responsible for the debt and budget crisis.  Arguably, fairness and economic justice require the rich and corporations to provide more tax revenues now and continue paying higher taxes.   Fairness aside, however, without additional tax revenue from them economic recovery will not be possible.

Republicans, however, have so far refused to consider tax increases.  Their mantra “decrease taxes” confuses taxes for rich people and corporations with taxes for everyone else.  For recovery and growth, taxes of the latter probably should be lowered in some respects, but taxes for the rich and corporations can and must be increased, for doing so is the only way to reduce deficits over time. [15]

Confronted on this point, Republicans argue that making rich people richer makes everyone better off, and taxing the rich and corporations just makes things worse.    That, however, is nothing but “trickle-down” Reaganomics, which is illogical and inconsistent with reality-based Keynesian macroeconomics.  Although Reaganomics has been proven wrong over the last 30 years, most recently by the Bush tax cuts, it remains the Republican party line.  This morning, for example, House Majority Leader Eric Cantor was interviewed on MSNBC News at about 7:15.   He said Republicans want to revive the economy and create jobs, but as for increasing tax revenues, he said, “You can’t get money out of thin air,” and “it’s counterproductive to tax those who are responsible for creating jobs.”

It’s simply nonsensical (and probably disingenuous) to suggest that rich people and corporations don’t have enough money to pay more taxes, when they have most of the money and are sitting on trillions of unproductive dollars.  And as for the “trickle-down economics,” argument, as economist Paul Krugman recently commented:  “On the face of it, this seems bizarre. Over the last two years profits have soared while unemployment has remained disastrously high. Why should anyone believe that handing even more money to corporations, no strings attached, would lead to faster job creation?” [16]

There is ample proof that the Bush tax cuts for the wealthy are exacerbating deficits and depressing the economy.  Last year a study by the Center for American Progress reported that the Bush tax cuts for wealthy people will cost $690 billion over the next ten years, and: “When we add in the costs of additional debt service * * * keeping those cuts for the rich will cost almost $830 billion.”  [17]

The Reaganomics arguments are so obviously wrong that I’m inclined to believe “trickle down” is less an article of ideological faith for Republicans than a fraudulent pretense for their self-serving agenda.  Wealthy people and corporations know what they can and cannot do, and they are aware of the trillions of dollars they possess.  It appears they hope the American people are too stupid and ignorant to understand the truth.

The question is, why go to the mat now, insisting on preserving all favorable tax provisions for rich people and corporations (and on reducing the deficit with painful cuts to Medicare and Medicaid and the off-budget Social Security program), under the threat of defaulting on the debt?  Republicans must not believe that we are all in this together, for on this slender thread of the fallacious “trickle down” argument they purport a willingness to send the country into default, and the economy into a chaotic demise, if they do not get their way.

Do they believe they will gain somehow from the destruction of the American economy?  Are they convinced voters will blame Obama when they refuse to raise the debt limit, and return the White House to a Republican in 2012?  Is it their objective simply to shut down the federal government?  Or is this all an elaborate bluff?

Perhaps with all the attention this budget crisis is getting Republicans may feel increasingly insecure about their control of American political discourse.  And with considerable backlash in states like Wisconsin, Ohio, New Jersey, Michigan and Minnesota — where the voters they had wooed in 2010 were unprepared for and strenuously opposed to corporate takeovers and union busting — they may now be worried that more people are catching on to their agenda.

If so, this threat to send the United States into default, with all of the grave harm that would cause, seems like a dangerous gambit.  At a minimum, just entertaining the possibility reveals an alarmingly high level of indifference to the well-being of the American people.

What are the bounds of recklessness and irresponsibility? We’ll know soon enough.

JMH – 7/7/11

Update – (7/12/11):  Today came news that Republicans are backing down on the threat not to raise the debt limit.  Mitch McConnell stated he supports legislation that would authorize the President to raise the limit unilaterally, as needed.  Stay tuned.

______

[1] “As Debt Limit Reached, Agreement Still Far off,” Damian Paletta and Carol E. Lee, The Wall Street Journal, May 16, 2011.

[2] “Reaching the Debt Limit: Background and Potential Effects on Government Operations,”CRS,  June 28, 2011.

[3] “Raising nation’s debt ceiling becomes high-stakes debate,” Nathan Hurst,  Detroit News Washington Bureau, June 10, 2011.

[4] “Debt ceiling fight could spark another recession, or worse,”  Ryan Witt, Political Buzz Examiner, April 11, 2011.

[5] “Debt Deadlock Should Have All of Us Afraid,” Ted Kaufman,  The Cagle Post, July 5, 2011

[6] “Republicans never demanded spending cuts to raise the debt ceiling under Bush,”  Ryan Witt, Political Buzz Examiner, June 28, 2011.

[7] “Battle Over U.S. Debt Limit Looms,” Donny Shaw for Open Congress, GovTrack Insider, November 1, 2010.

[8] “National debt by U.S. presidential terms,” Wikipedia

[9] Reality-Based World Archive for February 16, 2011.

[10] In 2010, the U.S. GDP was about $14.7 trillion. (“Economy of the United States,” Wikipedia), and GDP growth is slowing in 2011.  On its current trajectory, according to the March 30, 2011 projections of usgovernmentspending.com, the federal debt will grow from $14.3 to $15.5 trillion in FY 2011.  (Christopher Chantrill, usgovernmentspending.com).

[11] Christopher Chantrill, usgovernmentspending.com

[12] Christopher Chantrill, usgovernmentspending.com

[13] Christopher Chantrill, usgovernmentrevenue.com

[14] Rich Barbieri, CNN Money, 2/8/11

[15] A sensible argument can be made that the 15% tax rate applying to the ordinary incomes of people living at the poverty level could be reduced, while the 15% rate on high capital gains paid to millionaires and billionaires should be substantially increased.  Note that it was reducing the taxes on corporations and millionaires that caused increases in inequality and debt in the first place.

[16] Paul Krugman, The New York Times, Op Ed, July 3, 2011.

[17] “Three Good Reasons to Let the High-End Bush Tax Cuts Disappear This Year,” Michael Linden and Michael Ettlinger, Center for American Progress, July 29, 2010.  Linden and Ettlinger showed that progress on jobs, growth, real incomes was greater following the Clinton tax increases than after the GW Bush tax cuts:  (1) Under the first six years of the Bush tax cuts, jobs increased only 4.8% overall, while even after taxes were raised in 1993 during the Clinton administration jobs increased by 16.2%; (2) Overall economic growth was also much slower under the Bush tax policies, as real GDP grew by just 16% in the six years after the Bush tax cuts as compared to 26% in the six years after Clinton’s tax increases; and (3) following the Bush tax cuts “real income for the median American household went from $51,356 in 2001 to $52,163 six years later—an increase of just 1.6 percent. Under President Clinton’s tax rates, real median household income went from $45,839 in 1993 to $52,587 in 1999—an increase of 14.7 percent.”

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