Why The Debt Ceiling Is A Bad Idea

Despite some disagreements among Republicans, a new budget deal has passed through House of Representatives, raising the debt ceiling and pushing back another major budget debate to March 2017. Regardless of whether or not you think that the contents of the deal itself are any good, we should all be happy that something is passing that raises the debt ceiling.

There are a lot of misconceptions about what the debt ceiling is, which can be partially blamed on its misleading name. Even second place Republican presidential primary candidate Ben Carson seems to misunderstand it, saying that under his presidency, he’ll “address the budget immediately” and “will make it very, very clear that there will not be any budget signed that increases our debt ceiling.” This type of misunderstanding is very, very dangerous.

The debt ceiling, despite its name, is not actually a cap on how much debt the U.S. can incur. Even if we passed through the ceiling, we would still accumulate more debt. What the debt ceiling actually does is limit the amount of money that the government can pay back on debts we already have. It has nothing to do with new debt — only debt that we already owe. Former Minnesota Governor Tim Pawlenty, a Republican, compared it to ordering a meal at a restaurant, eating it, and then leaving without paying. Current Secretary of Treasury Jack Lew, a Democrat, agrees with the analogy.

Unlike refusing to pay for your food, the consequences of failing to raise the debt ceiling would be far more severe: a default on our debt. Despite the declarations of some Republicans that passing the debt ceiling would be no big deal, economists and investors say otherwise. U.S. bonds and the U.S. dollar are a staple of the global economy, and maintaining our full faith and credit helps keep interest rates low. Failing to raise the debt ceiling would put all of that into jeopardy. Former Federal Reserve Chairman Ben Bernanke said in 2011 that it “would no doubt have a very adverse effect very quickly on the recovery. I’m quite certain of that.” A 2013 report from the Treasury Department warned that:

“A default would be unprecedented and has the potential to be catastrophic: credit markets could freeze, the value of the dollar could plummet, U.S. interest rates could skyrocket, the negative spillovers could reverberate around the world, and there might be a financial crisis and recession that could echo the events of 2008 or worse.”

Others from around the globe agreed. Takatoshi Ito, a Japanese economist advising Japan’s $1.16 trillion dollar Government Pension Investment Fund, said that same year that “it would be worse than the Lehman shock,” referring to the collapse of the bank Lehman Brothers that triggered the 2008 economic crash. Leaders and high ranking officials from the Organization for Economic Co-operation and Development, the International Monetary Fund, and the World Bank all warned of the severity of a potential default.

In fact, the mere threat of a default contributed to investment ratings agency Standard and Poor’s 2011 decision to lower the rating of U.S. government debt for the first time in 70 years. Here’s the beautiful irony: because government debt received a lower rating, investors felt less confident in purchasing it. This made it harder for the government to get access to the credit it needs and ultimately resulted in higher interest rates on our government debt. A higher interest rate ultimately means government has to pay more to those with government bonds. According to estimates by the Bipartisan Policy Center, such higher interest rates will cost us $19 billion dollars over a decade. Thus, a policy intended to keep the debt in check succeeded only in increasing it.

Interestingly, something like this has happened before. Due to “severe technical difficulties,” the U.S. Treasury lost the ability to repay those with U.S. bonds for a brief period in spring 1979. This glitch, which effectively served as a small scale, short lived default on U.S. debt, resulted in a 0.6% increase in interest rates for the bonds, costing the government an additional $12 billion over the next year. The point to all of this being that if you want to keep the debt under control, you don’t mess with debt that has already been issued.

This is why, today, basically everyone who has studied it seems to agree that the debt ceiling is bad policy. Richard Thaler, behavioral economist at the University of Chicago, has argued that:

“If [congress] want[s] to reduce the deficit, they should cut spending, increase revenue, or both. But what they should not do, under any circumstances, is to look back at the decisions they have already made and conclude that it would be smart to declare the United States bankrupt, thus creating a second global financial crisis.”

Later, he was even more blunt: “The debt ceiling is a dumb idea with no benefits and potentially catestrophic [sic] costs if ever used.” He isn’t alone in this position. Those latter comments were made in response to a poll of 38 Ivy League economists conducted by the University of Chicago. Despite holding a variety of different political views, only one of the 38 disagreed with the statement that a debt ceiling “creates unneeded uncertainty and can potentially lead to worse fiscal outcomes;” 34 either agreed or strongly agreed with it. Beyond Thaler’s, other responses included “The question contains its own answer,” that it “seems hard to disagree,” that the debt ceiling is “nuts,” and, my personal favorite, former Obama adviser Austan Goolsbee’s seemingly exasperated response of “Obviously.”

What reason is there for the debt ceiling? Testimonial from officials at the non-partisan Congressional Budget Office called it “archaic” back in 1990, suggesting it didn’t even make sense 25 years ago. Even if we agreed that reducing the debt should be a national priority right now- and there’s an extremely strong case to only worry about our debt in the long-term- economists have come up with alternative policies to the debt ceiling that would be more effective at actually accomplishing it.

Perhaps it’s time to just get rid of the debt ceiling. After all, the only real purpose it serves today is as a negotiating tactic for congressmen who are willing to take the economy to the brink of collapse to pass their pet legislation. Looking at 57 votes to increase the debt ceiling that took place between 1945 and 1990, researchers Lance T. LeLoup and Linda K. Kowalcky of University of Missouri-St. Louis found that the debt limit is useful for those in congress who are looking to pursue their own goals:

“[Starting with the Nixon presidency,] Partisan disagreements between Congress and the executive inevitably slowed the policy-making process. As a result, members searched for alternative ways to accomplish legislative policy goals. Its must-pass nature made legislation increasing the statutory debt ceiling the perfect choice for riders. The increased frequency of these votes, spurred by rapidly rising debt, only increased their attraction. By the 1980s, the debt ceiling bill as a vehicle for amendments had become the norm.”

Sound familiar?

Originally published at theodysseyonline.com on November 3, 2015.

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