Debt Ceiling Explained

One problems with the current debt ceiling debate is that there appears to be widespread confusion about what exactly we are talking about. Much of the reporting focuses on the horse race and the daily-back-and-forth of the negotiations. Less effort has been expend trying to explain what the debt ceiling is, why we might wish to see it raised, and what will happen if we do not. It’s boring. It’s complicated. It involves absurdly large sums of money that we can’t really relate to. Worst of all, the topic is, currently, very political. Just wading in to try and understand it means getting caught in the crossfire of accusations.

But it’s important we understand what’s going on and what is at stake. Really important.

At the basic level, the debt ceiling is a pretty simple concept. The US government borrows lots of money to meet its various obligations. The debt ceiling was created by a law passed in 1917 and it determines the total amount of debt the government can have. It’s the limit on the US government’s credit card. It’s a self-imposed limit. The debt limit was created by an act of congress. It can be, and regularly is, increased by congress.

The US has reached the limit. We’ve borrowed all of the $14.3 trillion allowed. Unless the debt ceiling is increased, or a portion of the debt is paid off, the United States government can not borrow any money, at any rate, for any purpose. Ever.

Is that such a bad thing? If I’ve maxed out my credit card shouldn’t I try and pay some of it off instead of trying to increase my limit? Shouldn’t government balance its budget and live within its means?

In general, the answer is “yes”. The government should try to balance its budget. But it is also vitally important that government not cut off its own ability to borrow. There are times when we’re going to want to run a deficit.

For example:

Suppose the United States were to become involved in a war in another country. We might want to be able to conduct the war, and incur the inevitable expenses, even if we have not collected the taxes to pay for it all in advance.

Imagine we had an economic crisis. We might want our government to be able respond to that crisis and borrow money to support institutions that are essential to our economy and our future prosperity.

What if we had a period of very high unemployment? When the economy is in bad shape people need more government support but tax collection is falling as people lose their jobs. Without deficit spending the government has to cut back sharply just when people need it most.

Maybe we think that low taxes are a good idea in and of themselves. If we think low taxes increase liberty and prosperity and are important to economic growth, we might decide to keep taxes low and run a deficit rather than increase taxes to balance the budget.

How will we handle advances in medical science? We can live longer and healthier lives. But medical advances come at a considerable cost. We might choose these advances that improve and extend our lives and livelihood over a clean balance sheet.

Nature can be full of surprises. When there is a tornado, or a flood, or a drought we look to government to help mitigate the disaster.  A government that can’t borrow money won’t have the resources to deal with the unexpected.

And of course there is no guarantee that these issues will crop up one at a time. We might have to deal with several problems all at once.

A government that can not borrow money will be unable to deal with military conflict, ideological rigidity, an aging population, or any form of natural or economic calamity. This will create long-term difficulties.

There are times when we will want to run a deficit. Both of our major national parties agree that right now is one of those times. This spring the Republican controlled House and the Democratic Senate agreed to an annual budget that calls for $1.3 trillion in deficit spending.

That $1.3 trillion represents 44% of the federal budget. For every dollar the government spent $0.56 came from taxes and revenue and $0.44 was borrowed. If the debt ceiling is not raised then the United Stated government will not be able to meet 44% of its obligations.

It is difficult to overstate the implications of a sudden 44% federal contraction. Every month the federal government makes around 80 million payments to a wide variety of individuals and institutions. Soldiers, senior citizens, hospitals, doctors, contractors, federal employees, suppliers, researchers, law enforcement, holders of public debt, etc...  Every one of these recipients is getting money from the federal government because a law was passed saying they are entitled to it. Behind each of these payments is a program, an appropriation, a law or a budget agreement that is just as real, lawful, and binding as the debt ceiling law.

If the debt ceiling is not raised then 44% of those obligations can not be paid. Each one of those recipients is entitled to the money. They are entitled to sue the government seeking the funds that we are contractually obligated to pay them. The government will have no means of meeting its obligations and it will default.

In addition to national default. All the people expecting to get all of those billions of dollars will, suddenly, not be getting them. Employers won’t be able to make payroll, hospitals will not be able to pay their bills, federal employees won’t get their paychecks and won’t be able to pay their mortgages.

Running up against the debt ceiling would not be one-time event. It would be a permanent condition. The debts, obligations, and needs we have in 2011 are not going to go away in 2012 or 2013. Millions of federal contractors and employees who are not getting paid and are suing the government will make things worse. The international community will rapidly withdraw its funds from the US. They will invest in other nations that have not abandoned their obligations.

Failure to raise the debt ceiling would be like the economic collapse of 2008 combined with a permanent government shutdown.

So... we should raise the debt ceiling.

The good news is that the economic cataclysm can be averted by calling a vote to avert it.

The bad news is that many of our elected representatives are refusing to do so.

Debt Ceiling End Game

The Washington Republicans have taken our economy hostage, threatened to kill it if their demands are not met, and walked away from the negotiations. How should the President and the Democrats respond to this? The clock is ticking towards disaster. How is the standoff going to end?

The GOP seem to think that since the President cares about his country, and would prefer not to see an economic cataclysm, that the he will give into their demands. The debt ceiling vote is the only chip they are willing to put on table. They think it should be worth several trillion dollars in spending cuts.

As chips go, the value of the debt ceiling increase has to have a value of precisely nothing. Regardless of who gets the blame, a US debt default and sudden federal contraction will be devastating to futures and fortunes to Americans regardless of party. The Republicans have made a threat they can’t possibly follow through on.

This doesn’t mean the deficit reduction talks can’t be productive or that they shouldn’t resume. But it needs to be a negotiation and not a hostage situation.

There are a few ways this can play out. In order of desirability they are:

1. Congress and the President reach an agreement on long-term debt reduction. They also vote to increase the debt ceiling.

2. The debt ceiling is simply raised without any any other agreements.

3. There’s no agreement on anything. Obama claims the debt ceiling is unconstitutional and resumes borrowing. The US does not default on its debts. There is no sudden economic collapse. The US political system is demonstrated to be deeply dysfunctional.

4. The Democrats give in the GOP’s economic extortion and just given them whatever they want in exchange for an debt ceiling increase. The terrorists win.

5. There’s no agreement. There’s no debt limit increase. Obama accepts this. The US defaults on its debt. The federal budget is immediately slashed by 44%. The economy collapses. Again.


What will really happen?

Despite the current impasse. I’m going to bet on #1. There will be a negotiated solution.

The administration has already agreed substantial spending cuts. And they should. We’re in our third year of trillion dollar deficits. We need a path towards a sustainable budget and we’ll need spending cuts to get there. We’ll also need revenue increases. The President to right to insist on those. The GOP is being childish to assert revenue can’t be part of debt reduction solution. It has to be.  But a long term deficit agreement this summer can be lopsided in favor of cuts over revenue. The major Bush/Obama tax cuts are expiring after 2012. This affords us time to reconsider long term tax policy. If no agreement is forged the outcome is higher taxes and lower deficits.


The other likely outcome is #3. The GOP has painted itself into a corner with it’s own rhetoric. It’s not clear that House majority can, or will, consider a negotiated solution to the crisis they have created. They may steer the country towards deliberate bankruptcy. If that happens then President Obama must ignore the debt ceiling legislation and assert his authority to insure the nation does not enter insolvency.

This outcome has certain advantages for Washington Republicans. They avoid a vote on the debt ceiling. They don’t have to vote to increase revenue or to close tax loopholes for oil companies or jet owners. The GOP and it’s enablers will howl that the President’s actions are illegal. It will require considerable chutzpah to demand national disaster. But I’m confident the right-wing propaganda machine is up to the task.

There are downsides to the GOP for an Obama-averted default. Deficits would continue to rise. This outcome would be the ultimate abdication of legislative responsibility in the service of rigid ideology.

Will the GOP choose it anyhow? We shall see...

Armageddon

In the 1998 Micheal Bay thriller Armageddon there’s this giant asteroid on it’s way to destroy the earth. Naturally, it’s up to Bruce Willis and his plucky, quirky companions to saved the world. But before they do, they have some demands.

“We don’t want to have to pay taxes. Ever.”

When I first saw this scene I thought to myself: Well, that’s pretty stupid. In the face certain calamity nobody could possibly be so petty. If there’s a pending disaster that will destroy you and everyone you hold dear, how could someone with the power to avert this catastrophe refuse to so? So they can argue over tax rates? Who could be that craven and stupid?

After watching the debt ceiling debate in Washington, we have our answer. The entire Washington GOP is precisely that craven and stupid.

First the GOP took the incredibly irresponsible step of taking the US economy hostage. They are threatening to destroy it by refusing the raise the debt ceiling unless the Democrats agree to trillions of dollars in spending cuts. Now, the Republicans have walked out of the negotiations, after trillions of dollars of spending cuts have been agreed to, because the Democrats has also suggested revenue increases.

This is madness. Unlike, Bruce Wills the GOP isn’t even being asked to climb a rocket and blow up a giant asteroid. If they want to avoid economic armageddon all they have to is call a vote to avert it. The fact that they refuse to do so tells you how irresponsible they have become.

You Balance the Budget

Back in my Federal Budget Blueprint series I took a look at how we should deal with our trillion dollar budget deficit. This was a useful exercise and something everyone should consider. What do you want? How do you want to pay for it?

Everyone should consider this. And thanks to a spiffy new website created by The Committee for a Responsible Federal Budget now everyone can!

On their site you can punch in your priorities. Choose your spending and tax policy. Steer a grateful nation towards a path of fiscal sanity or financial ruin. You decide!


I was able to plug in a version of my plan and was pleased to see that my preferred path led to a sustainable place with debt at 48% of GDP, well below the suggested 60% target. But then, I call for spending cuts and tax increases. Because, you know, trillion dollar deficit...

If an all-powerful genie granted me one wish -- and if that genie made it clear that I could only use my wish to influence election policy -- then here's my wish: Every politician running for any federal office would have to take this budget calculator for a spin and publish the results.

Think about it. Instead of inane platitudes and vacuous campaign slogans (Ok, in addition to inane platitudes and vacuous campaign slogans. I only got the one wish.) we would have an actual breakdown of a real plan. We could learn their actual priorities before we voted for them.

And anyone who says they are going to "cut taxes and reduce the deficit" could explain how the hell we're supposed to do that.

My choices...

FBB Part 4: Health Care

Critics of health care reform claim that now is not the time for it. With massive deficits and in the midst of a serious recession this is the wrong time to reform our health care system. President Obama has said the opposite. "Put simply, our health care problem is our deficit problem. Nothing else even comes close." The president is correct.

For more than a decade, private health care costs have had an average increase of more than 10% per year. The federal Medicare program cost $217 billion in 2000 and accounted for 2.3% of GDP. 10 years later Medicare cost $453 billion which is 3.5% of GDP. For the government, medical costs are growing faster than then economy. For the private sector it is worse.

Rising medical costs wiped out median income growth over the last 10 years despite rising productivity. Employers are cutting back on medical benefits they can no longer afford and passing the extra costs onto their employees. State budgets are swamped by rising Medicaid expenses. Municipal budgets are being squeezed.

We need to control rising health care costs in this country. That won't happen without comprehensive reform. Here, the status quo can not help us. Things are bad now. On our current path they continue to get worse. Much worse.

It may seem impossible to reign in medical costs. But many other countries manage to attain similar outcomes and life expectancy at half the cost. The nice thing about having a bloated, inefficient, patchwork system with few market incentives, local monopolies and inadequate cost control is this: There's room for improvement.

As a first step we must enact the health care reform bills before Congress today. Making affordable health insurance available to all Americans is a moral imperative. It will be an achievement worthy of celebration. It is also essential to control cost. Broader access to insurance will mean fewer emergency room visits, fewer medical bankruptcies, and fewer unpaid medical bills that get passed on as cost hikes for paying customers. Giving Americans access to a national health care exchange will provide more options and break local insurance monopolies. Eliminating exclusion based on health care history will mean health insurers will no longer be able to compete via risk management. They will no longer make profits by finding healthy customers and barring those that might get sick. Health insurance companies will be forced to compete by providing superior products at attractive prices. Instead of competing to keep away sick people they will have to learn to efficiently take care of them.

Beyond the basics of the bill, authors of the health care reform bill deserve a lot of credit for their thoroughness and dedication to creative cost control. The bill introduces market-based reforms such as price transparency. It includes a number of technical measures designed to reduce cost without cutting benefits. And much of the bill's frequently-maligned bulk comes for a host of pilot programs and experiments. These are designed to be tested on a small scale before the most successful ones are implemented and replicated nation-wide.

This is essential reform. We cannot afford to let it fail.

There are critics from across the ideological spectrum who say the cost cutting measures in the health care reform bill are insufficient. They may be correct. The current effort is an indispensable step. It it a giant leap forward. But really taming health care cost inflation may require we do even more.

There is a deep divide between the left and the right on the proper solution to health care cost inflation. Reformers on the right claim the insurance model itself is the source of the problem. Because consumers of care are separated from its cost they consume more than they otherwise would. People over-utilize and overpay because the bill is paid by someone else.

Reformers on the left point to model used in Europe, and Canada, and well, most every country on Earth. The public health is treated as a public good. The government provides for the health care of its citizens and manages the cost. It can control cost via massive purchasing power and regulatory authority.

If it to comes to Health Care Reform Part II (Secret of the Ooze?) the recommendation from Bank Slate health care economics team is that the American solution should borrow from both the left and the right. Do both. The government should offer a variety of public options and Medicare buy-ins. Some of these options should control cost aggressively. Some public plans should be less constrained. All plans should be priced to consumers to reflect their actual cost. Private health insurers should also be free to offer HSAs, high deductible plans, and other options that do more to put health care choices (and cost burdens) in the hands of consumers. Everyone gets their mandate. Poor people get their vouchers. Americans get to vote with their dollars and their feet.

Of all the budget problems we face, rising health care costs pose the greatest risk to our nations financial health. The one thing we can least afford to do is nothing at all.

Part 4 of the Bank Slate Federal Budget Blueprint series.

FBB Part 3: Military Budget

Part 3 of the Bank Slate Federal Budget Blueprint series. The goal of this series is to make realistic recommendations that would allow the US to balance in the budget within 10 years. The basic tenants of the the Bank Slate Federal Budget Blueprint are:

• The year 2000 should be used as a policy baseline. Tax and spending policies should be reset to the levels and rates they had in 2000.
• Any policies enacted since 2000, that we wish to keep, need to be funded.

In the year 2000 U.S. military spending was $311 billion. Ten years later, the US defense budget has more than doubled and stands at $685 billion. Included in the $685 are the operating costs of the wars in Iraq and Afghanistan. That number does not include other defense-related spending such as Homeland Security and Veteran's Affairs. If those are included, total defense spending hits $1 trillion.

In 2010 defense spending in the US will be roughly equal to the combined military and defense spending of every other country on Earth.

Despite the massive expenditures, elements of the US military have been overextended by 7 years of war in Iraq and Afghanistan. Army, Army Reserve, Marine, and National Guard units have all been called up for multiple overseas combat deployments. Both of our ongoing wars have been plagued by the fact that our resources (primarily troop counts) have been insufficient given the magnitude of the missions. We've needed more, not less.

And then there's that $1.56 trillion budget deficit. What to do?

If there's one lesson to be drawn from the wars of last 60 years it is this: The age of empires is over. Historically, a great nation could increase its power and enrich its citizens via military conquest. In recent decades, in Vietnam, Afghanistan, Chechnya, Lebanon, Afghanistan (again), Iraq, and around the world insurgencies with minimal funding have been able to draw great nations into pointless, bloody, protracted stalemates. "Victory", if it comes at all, comes with a price well in excess of its value. The conquering of nations no longer serves anyone's economic purposes and may no longer be viable for anyone. Global economic interdependence makes conventional warfare between nations increasingly pointless and its likelihood increasingly remote. We have the power to destroy any nation's armed forces, but there is not much call for it. We lack the capacity to pacify any country at a price worth paying.

After a decade of asking to US military to do more and more with more and more it's time to change our motto. The military should be asked to do less with less. We should maintain our conventional superiority, but we can do this with less than we have now. We should recognize that militias, gangs, and warlords can wreak localized havoc and be prepared to be a strong and active partner in peacekeeping and stability operations. We should recognize that large scale military occupation and nation building is a fruitless activity that comes at great cost, and not much benefit to the American taxpayer.

The 2010 budget allocates about $128 billion to the wars in Iraq and Afghanistan. We should continue the withdrawal from Iraq this year. We will add more troops the Afghanistan this year. But we should follow through plan to begin withdrawing troops and winding down the war in 2011.

The baseline budget for the military should be maintained at around $550 billion and left there for the foreseeable future. End the wars in Iraq and Afghanistan and avoid new overseas adventures. Freeze the remaining budget at current levels. With inflation and economic growth this will mean, effectively, a slow reduction in spending. Without a blank check, the military will have do a more rigorous analysis of our actual needs and adjust expenditures appropriately. Years of spending increases have gotten us to a $1.56 trillion deficit. More and more is a luxury we can no longer afford. It is also something we no longer need.

FBB Part 2: Taxes

Part 2 of the 'Bank Slate Federal Budget Blueprint series. The goal of this series is to make realistic recommendations that would allow the US to balance in the budget within 10 years. The basic tenants of the the 'Bank Slate Federal Budget Blueprint are:

• The year 2000 should be used as a policy baseline. Tax and spending policies should be reset to the levels and rates they had in 2000.
• Any policies enacted since 2000, that we wish to keep, need to be funded.

Politicians and the good citizens they represent always think taxes should be lower. If times are bad, or maybe they aren't so bad, but we want them to be better-- we can stimulate the economy by cutting taxes. And if times are good and there's a budget surplus-- well then that's not the government's money. That's your money! You should get it back.

For Republicans there is no problem that can't be solved by cutting taxes. Even today they all promise to "cut taxes and reduce the deficit". There is no political cost to uttering this nonsense.

Even the Democrats have gotten in on the act. Clinton and Obama both realized that calls for spending increases will be met with protest. But everyone likes a targeted "tax credit". These are much easier to pass even if the result is pretty much the same.

 Nobody like taxes. I don't like taxes. I don't like paying my credit card bills either. But if you're going to spend the money you've got to get it from somewhere. Somewhere means income or debt. Conservatives say they don't like the government spending all this money. But their commitment to tax cuts is not matched by a commitment to spending cuts.

After a decade of tax cuts for all seasons, we're looking at a $1.56 trillion 1 year budget deficit. There is no party willing to enact tax hikes. And there are no Americans who are going to demand it.

Fortunately, there is a simple solution. In fact, it's the simplest of all possible solutions. Congress should do nothing at all.

In their wisdom, the Bush Administration and its congressional supporters, scheduled all of the Bust tax cuts to expire this year. At the end of 2010 all the Bush tax cuts -- income, capital gains, estate etc.. are scheduled to reset to their 2000 level. Obama's tax cuts are also scheduled to expire in a year or two. Obama has suggested that congress should extend some of the tax cuts that go to "working families". Congress should not do this. The projected deficit is $1.56 trillion. We can't afford the tax cuts. Not even the ones that go to me.

The other tax that congress should to nothing about is the AMT. The AMT (Alternative Minimum Tax) was enacted in 1969 and designed to make sure Americans with high incomes couldn't hide all of it in tax shelters. The problem with the AMT is that it didn't account for wage growth over time. What was considered "high income" in 1969 counts is considered to be "middle-class" today-- although we still mostly talking about couples with income over $200k.

Every few years congress "fixes" the AMT by bumping up the level where it goes into effect. But the AMT is a simple, progressive tax system. So, we should leave it alone, even if I end up paying it some day.

Raising taxes is always a bitter pill to swallow. But reverting to year 2000 tax policy will be much less nasty than ongoing $1.56 trillion dollar deficits. And all congress has to do is nothing at all.

Bank Slate Federal Budget Blueprint

One of the many reasons to condemn the Bush administration is its record of fiscal irresponsibility. In the final year of the Clinton presidency we had a 236 billion dollar budget surplus. At the end of the Bush administration, after a few unfunded entitlements, massive tax cuts and 7 years of warfare, the days of surplus were long gone. In 2008 the budget deficit was 454 billion dollars. The Bush record was one of constant tax cuts and spending increases. The result was predictable. He even oversaw the disintegration of our financial system left a pending depression as little parting gift.

Obama inherited a budget awash in red ink and an economy on the brink of collapse. He responded by cutting taxes and increasing spending. A lot. Well respected Keynesian-economic orthodoxy says this was the exactly right thing to do under the circumstances. Facing an economic crisis, the government should borrow a lot and spend a lot to get the economy moving again. The debt is worth incurring if it gets people working and prevents stagnation. And the theory worked. Sort of. The economy and unemployment stabilized. It's bad but it could have been worse. Much worse.

Stability came at a great cost. The 2009 budget deficit was a jaw-dropping 1.35 trillion dollars. In the first year of the Obama administration the government ran up 1 year deficit that was three-times that of the worst Bush budget. Still, it was a crisis. Now the worst has passed. Obama has been in office for a year. Earlier this month he unveiled his own budget plan. The Obama budget for 2010 projects....

... a 1.56 trillion dollar deficit.

In 2010 we'll see more tax cuts and more spending. Naturally, the Republican party finds these runaway deficits to be completely intolerable. If they were in charge they would... um... cut taxes even more!

We have a big problem.

With a total federal debt over $12 trillion it won't take many years of trillion plus deficits before this country is in big trouble. In the long term runaway spending will be ruinous. But in the short term cutting taxes and increasing spending is always popular. Cutting spending and raising taxes is political suicide. Especially with a battered economy and unemployment over 10% -- any party that calls for belt tightening will get run out of town.

What to do?

Here is my solution. There are some relatively simple measures we can take that should be politically palatable, would put us on a sustainable path to a balanced budget, and are vastly preferable to national bankruptcy.

I'll dive into some specifics in future posts. But the basics are pretty simple. Remember the year 2000 when we had a surplus of $236 billion? That wasn't so long ago. Were you crushed by the weight of over-taxation in 2000? Did you find the federal government of 2000 to be overly stingy with the public purse? 2000 was an Ok year, right?

The Bank Slate Federal Budget Blueprint:

• The year 2000 should be used as a policy baseline. Tax and spending policies should be reset to the levels and rates they had in 2000.
• Any policies enacted since 2000, that we wish to keep, need to be funded.

A lot has changed since 2000. Not enough had happened to justify perpetual trillion dollar deficits. But there have been changes. As the Bank Slate Federal Budget Blueprint series continues I'll dive into the big-ticket changes and how we can bring them back a sensible baseline. Specifically, I'll look at:

• Taxes
• Military Spending
• Health Care

Stay tuned...