By James Carter and Pete Davis - 11/14/12 11:41 PM EST
House Speaker John Boehner (R-Ohio) has a problem. With the federal government approaching its debt limit of $16.394 trillion, some 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 score political points.
Speaker Boehner understands the risks of not increasing the debt ceiling, calling a failure to do so “a financial disaster, not only for our country, but for the worldwide economy.” We agree that 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 with significantly higher interest rates on newly issued federal debt.
The first debt limit was established by the Second Liberty Bond Act of 1917 as Congress’s condition to sell bonds to finance World War I. It was raised repeatedly over the next two years by the Third and Fourth Liberty Bond Acts and the Victory Liberty Loan Act. 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 percent of gross domestic product in 1940 to a peak of 121.7 percent in 1946. Although the federal government ran budget surpluses in only eight of the 35 years that followed, those years saw a dramatic decline in the gross federal debt relative to GDP as annual economic growth generally outpaced debt growth. By 1981 the gross federal debt had fallen to 32.5 percent of GDP. Nonetheless, Congress increased the debt limit dozens of times because the debt continued to grow in dollar terms while shrinking relative to GDP.
Since 1981, the gross federal debt has ballooned both in dollar terms and as a share of GDP. With Congress increasing the debt limit 40 times over the past 30 years, gross federal debt is rapidly approaching 100 percent of GDP today. Obviously, if the debt limit was intended to limit debt, it’s not working.
Economists generally agree we should abolish the debt limit. Once government spending and tax decisions are made, the only question remaining is whether to honor our obligations. Former Federal Reserve Chairman Alan Greenspan said as much on April 10, 2011, on “Meet the Press” when he asked “Why do we have a debt limit in the first place?”
“We appropriate funds or we have tax law, and one reasonably adept at arithmetic can calculate what the debt change is going to be,” he said. “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 handy, must-pass piece of legislation on which all manner of amendments can ride into law. Additionally, a vote against the debt limit can give spendthrift members of Congress the appearance of fiscal responsibility.
So if we’re going to have a debt limit, why have a limit with no basis in economic reality? The current limit covers more than 99 percent of total federal debt and, generally speaking, caps publicly held federal debt and debt held by federal accounts such as Social Security Trust Funds. Yet, an increase in the debt held by the federal government has no economic impact — it merely represents an increase in the authority, but not the means, to pay promised benefits. The fiscal burden of providing benefits is felt as benefits are paid, so trust fund debt is a distraction with no connection to economic reality and little connection to the true size of the government’s unfunded liabilities.
In fact, given that publicly held debt is just under $11.4 trillion, the existing debt limit of $16.394 trillion could be lowered to $13 trillion, leaving enough room to accommodate the federal government’s anticipated borrowing needs for at least another year. Congress could avoid a potentially disastrous fight over raising the debt limit and we could focus on the debt that matters for economic growth: the debt held by the public.
Carter was a deputy assistant secretary of the Treasury under former President George W. Bush and served on the staff of the Senate Budget Committee. Davis served on the staffs of Congress’s Joint Committee on Taxation and the Senate Budget Committee.