If We Have To Have A Debt Limit, Let's Have One Which Reflects Economic Reality

Old but relevant.

http://capitalgainsandgames.com/blog/pete-davis/2224/if-we-have-have-debt-limit-lets-have-one-which-reflects-economic-reality

If We Have To Have A Debt Limit, Let's Have One Which Reflects Economic Reality

James Carter and Pete Davis



Today, Jim Carter and I wrote this op-ed in Investor's Business Daily. Until recently, Jim was Chief Economist at the Senate Budget Committee Minority and Deputy Assistant Secretary of Treasury.

House Speaker John Boehner has a problem. With the federal government rapidly approaching its debt limit of $14.294 trillion, more than a few members of the House have said they won't vote to increase it.

Some oppose raising it as a matter of principle. Others are willing to raise it, but only if the increase is accompanied by spending cuts and budget reforms. And then there are those who simply want to make the most of this opportunity to score political points.
For his part, Speaker Boehner understands the risks associated with not increasing the debt ceiling, calling a failure to do so "a financial disaster, not only for us, but for the worldwide economy."

We agree. Any failure by the government to meet all of its obligations would result in a lasting downgrade by rating agencies that would saddle future generations of Americans with significantly higher interest rates on newly issued federal debt.

Yet, for all the fuss over the debt limit and the potential disaster we face, this crisis is not only avoidable, it's unnecessary.

The first debt limit was established by the Second Liberty Bond Act of 1917 as Congress' condition for allowing the Treasury to sell bonds to finance World War I. The limit was raised repeatedly over the next two years by the Third and Fourth Liberty Bond Acts and the Victory Liberty Loan Act.

The Treasury had great difficulty selling enough bonds to finance the $32 billion cost of World War I, even as it raised interest rates on each successive bond issue, so the debt limit served as a cosmetic to persuade buyers that their bond purchases would hold their value.

World War II took gross federal debt from 52.4% of GDP in 1940 to a peak of 121.7% in 1946. Although the federal government ran budget surpluses in only eight of the thirty-five years that followed, those years saw a dramatic decline in the gross federal debt relative to GDP as, more often than not, annual economic growth outpaced debt growth.

By 1981, the gross federal debt had fallen to 32.5% of GDP. Nonetheless, Congress increased the debt limit dozens of times during that period because the debt continued to grow in dollar terms even as it shrank relative to GDP.

Since 1981, except for a five-year respite starting in 1997, the gross federal debt has ballooned both in dollar terms and as a share of GDP, prompting Congress to raise the limit forty more times. Gross federal debt is rapidly approaching 100% of GDP. Obviously, if the debt limit was ever intended to limit the debt, it's not working very well.

Economists generally agree that we should abolish the debt limit. Once government spending and tax decisions have been made, the only question is whether to honor our obligations.

Former Federal Reserve Chairman Alan Greenspan said as much during last Sunday's "Meet the Press."

"Why do we have a debt limit in the first place?" he asked. "We appropriate funds or we have tax law, and one reasonably adept at arithmetic can calculate what the debt change is going to be. The Congress and the president have signed legislation predetermining what that number is. Why we need suspenders and belts is something I've never understood."

Congress won't abolish the debt limit because it's a very handy must-pass piece of legislation on which all manner of amendments unrelated to the budget can ride into law and because a vote against the debt limit can give a spendthrift member of Congress the appearance of being fiscally responsible.
So if we're going to have a debt limit anyway, why have a limit that has no basis in economic reality?

The current limit covers more than 99% of total federal debt, including publicly held debt and debt held by federal accounts (e.g., the Social Security Trust Funds). The latter is just the authority, but not the means, to pay promised future benefits to ourselves. The fiscal burden of providing those benefits is not felt until the benefits are paid. So trust fund debt has no economic impact. It's just a distraction.

As we grapple with the hard work of deficit reduction over the coming years, why not exclude debt held in federal accounts from the debt limit? Given that publicly held debt is just under $9.7 trillion, the existing debt limit of $14.294 trillion could be lowered to $12 trillion, leaving enough room to accommodate the federal government's anticipated borrowing needs beyond the 2012 elections.

Congress could avoid a potentially disastrous fight over raising the debt limit, and we would focus on the debt that matters for economic growth: the debt held by the public.

Interesting. But how is it that debt held in federal accounts has no economic impact?

We are sending out Social Security checks every month. And every month, more and more of those checks are going out as boomers retire. This would seem to have an economic impact from where I sit.

Obama has threatened that these checks would not be forthcoming if the debt ceiling wasn't raised - seems to me these checks have an economic impact.

I don't get this part of the article.

I can solve this problem; enact an amendment to the constitution that says the congress must have a balanced budget each and every year. Many states have that in their state constitutions.

This has been put forth by the Senate Repubs. Guess what? The Dems controlling the Senate say that there will be no discussion of a bill to amend the constitution that says the US budget must be balanced every year. Surprised? Nope.

dblboggie wrote:Interesting. But how is it that debt held in federal accounts has no economic impact?

We are sending out Social Security checks every month. And every month, more and more of those checks are going out as boomers retire. This would seem to have an economic impact from where I sit.

Obama has threatened that these checks would not be forthcoming if the debt ceiling wasn't raised - seems to me these checks have an economic impact.

I don't get this part of the article.

Social Security checks are funded by payroll revenue, not the Social Security Trust Fund (a federal account).

The Social Security Trust Fund is a pool of money--basically, money taken from taxes to fund Social Security payments, which is in excess of what is actually needed to make the payments. It's a surplus; an overpayment. The gov't hangs onto it, and it's considered debt--we owe it to Social Security recipients when the day comes that revenue can no longer cover it.

I believe the author's point is that this isn't really debt yet. It's future debt that we haven't incurred yet. So (according to him), it's inaccurate to include future debt (however certain it is that it will accrue) as part of our present debt.

Ah... okay... I see what you're saying. Unfortunately the so-called Social Security Trust Fund is full of IOU's by the federal government. There is no cash there, it's full of government bonds (the same bonds we're selling to the Chinese and other countries, not to mention our own citizens) and these bonds are simply a promise that we are going to pay on these and not actual money. The federal government has been seizing Social Security money for decades and using it in the general budget - replacing that money with bonds.

So in point of fact, the trust fund is debt and not money.

At least this is how I understand our current position.

I mean, there is no actual money in the Social Security Trust Fund, it's all government bonds. In my mind, bonds are debt.

Am I missing something?

You're right about the nature of the trust fund; I stand corrected. I suspect the argument is still the same: the bonds are future debt, not present debt, because the gov't currently has no obligation to write checks out to people who are not yet eligible for Social Security.

That's what I think their answer would be--but really, you'd have to ask them.

I posted this article because 1) I had no idea that the debt ceiling had been raised so many times--so why the sudden raging controversy over whether default is an option?--and 2) because I agree with the authors' view that we should abolish the debt limit, for the reason given by Alan Greenspan in bold.

kronos wrote:You're right about the nature of the trust fund; I stand corrected. I suspect the argument is still the same: the bonds are future debt, not present debt, because the gov't currently has no obligation to write checks out to people who are not yet eligible for Social Security.

That's what I think their answer would be--but really, you'd have to ask them.

I posted this article because 1) I had no idea that the debt ceiling had been raised so many times--so why the sudden raging controversy over whether default is an option?--and 2) because I agree with the authors' view that we should abolish the debt limit, for the reason given by Alan Greenspan in bold.

You know, I think I agree with you on this point. The fact is, the debt limit is not constitutionally required, and it certainly doesn't limit our debt, so what good is it?