The Federal Debt Ceiling
By Scott J. Brown
May 23, 2011
Last week, the federal government breached the current debt ceiling, $14.284 trillion. The Treasury had begun taking evasive action the week before, but warned that it couldn’t do so beyond early August – and Congress would have to raise the debt ceiling before then. Will the government default? The strong betting is that it won’t. The bond market doesn’t seem to be worried. However, the increased rhetoric could have a bigger impact on the equity and currency markets.
Why does the government have a debt ceiling? For the most part, it’s an historical artifact. The government controls additions to the debt (the budget deficit). There’s really no good reason to have a limit. About a third of the federal debt ($4.6 trillion) is money that the government owes itself: government employee retirement funds, and the Social Security and Medicare trust funds. Marketable debt (Treasury bills, notes, and bonds) currently totals $9.7 trillion, or 65% of GDP.
The bond market appears complacent about the debt ceiling being raised. There are a couple of reasons for this. One is that the debt ceiling must be raised. To do otherwise would risk catastrophic damage to the U.S. economy and the global financial markets. The other reason that the bond market is complacent is that we’ve been here a number of times before. One party always thinks that it has the other over a barrel and is going to get whatever it wants. However, no one wants to be blamed if the debt ceiling isn’t raised. This time, there are a few lawmakers who actually think that not raising it would be a good thing, a slap across the face which would serve as a catalyst for more dramatic adjustments to the budget trajectory. However, this is very much a minority opinion. Business leaders, especially those on Wall Street, have implored lawmakers to raise the debt ceiling as soon as possible. In the end, the debt ceiling will be raised, because it has to be raised.
Does raising the debt ceiling mean that we don’t have to worry about federal budget deficit? Of course not. However, we need to be careful here. For the most part, tax and spending policies are political decisions, not economic ones. One side says that spending is out of control, ignoring the run-up in the national debt during the previous decade (two unfunded wars and an unfunded Medicare prescription drug program). The other party bemoans mean-spirited cuts in the public safety net, not appreciating that spending has to be financed by additional taxes or more borrowing. However, why does the rhetoric have to be so heated? Can’t the two parties make concessions?
It’s interesting to note that if you currently cut out all of the federal budget except Social Security, Medicare, and defense spending, you would still have a deficit. Nondefense discretionary spending includes many functions worth having, funding for law enforcement and justice, transportation infrastructure, and so on. Reducing the deficit realistically means higher taxes, cuts in entitlements, or some combination.
A bigger issue is tax expenditures. These are legislated reductions in taxes: personal tax deductions (such as the mortgage deduction) and corporate tax breaks. For budgetary purposes, tax expenditures act just like spending, adding to the federal budget deficit. They are expected to total nearly $1.3 trillion in the current fiscal year (in comparison, nondefense discretionary spending is running at less than $900 billion). You could balance the budget right there. Realistically, we could reduce tax rates and eliminate these special breaks as part of a broader tax reform. However, people (and corporations) like their tax breaks and it’s hard to change the system.
Hysteria over the federal budget deficit comes and goes over the years. We’ve been here before. Stronger economic growth will help relieve a lot of strains, but inappropriate and poorly timed action would actually make the economy worse off.
(c) Raymond James
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