Congress’s Debt Limit Problem Is Toddler Fiscal Policy

Partisan congressional squabbling over the nation’s debt limit once again threatens to shut down the federal government and perhaps trigger a worldwide financial crisis.

The debt limit as currently structured is toddler fiscal policy.

Every parent of a young child knows what I am talking about: Little Peter gets all dressed up in his snow suit—a cumbersome process—and then announces that he has to go potty. Snow suit is stripped off, Peter relieves himself, and the snow suit is reapplied. It would be so much more efficient, and much less risky, if Peter went to the bathroom before suiting up.

When it comes to the debt limit, Congress has the same problem.

The borrowing cap takes effect years after Congress enacts the tax or spending policy that requires an increase in the debt limit. It never accomplishes its ostensible goal of reining in federal finances. If there is to be a debt limit at all, Congress should increase it at the same time it approves the tax cuts or spending increases that make the hike necessary. It is pointless to wait until after the consequences of past policy decisions are inevitable.

Legislators pass laws they know will increase the debt but postpone increasing the borrowing limit until the country is on the verge of a catastrophic default. In the meantime, Treasury is forced to waste taxpayer dollars by routinely engaging “extraordinary measures” to allow the nation to continue to finance its debt. This description is a misnomer since the measures have, in fact, become ordinary.

The most benign work-around is borrowing from federal employees’ retirement funds, which Congress has explicitly authorized. Treasury also can postpone payments to contractors, which sometimes triggers late-payment penalties. Even without an explicit interest penalty, those who provide services to the federal government are likely to price the risk of late payments into their contract prices.

And, of course, Treasury must waste staff resources to undertake extraordinary measures and later undo them once Congress finally increases the debt limit and normal borrowing can resume.

We are currently approaching the latest debt X-date, when all extraordinary measures have been exhausted. The Bipartisan Policy Center (BPC) estimates that will occur by mid-November. BPC says that the approaching x-date has begun to push up yields “…on some short-term Treasury securities, indicating that financial markets are already concerned and that extended congressional negotiations are themselves costing federal taxpayers money.”

While debt limit advocates claim to care about fiscal responsibility, this game of fiscal chicken never has provided more than temporary leverage to eliminate or reform spending programs they view as wasteful. Lawmakers have, however, used debt limit as leverage to create symbolic but largely ineffective budget “reforms” such as Gramm-Rudman-Hollings, the Budget Control Act, and the dysfunctional supercommittee.

But breaching the debt limit is no way to achieve real fiscal reform. A US federal government default could create a worldwide financial crisis that could make the 2008 collapse look like a minor disruption. And the cost of federal borrowing could be much higher for a long time. Higher interest payments would make our federal debt bigger and riskier, not smaller.

Because the consequences are so dire, this high-stakes game of debt-limit chicken always ends the same way: Congress raises the borrowing cap just before calamity strikes. The theater does little more than waste money and generate a lot of breathless commentary.

There is an alternative: Require Congress to authorize the necessary borrowing when it enacts the spending or tax legislation that causes the deficit to increase. A rule developed  by then-Congressman Dick Gephardt (D-MO) did this between 1979 and 1995.

When Congress passes spending or tax bills, the Congressional Budget Office and the Joint Committee on Taxation already estimate their budgetary effects. They easily could add interest payments to calculate estimated effects on the debt. If deficit hawks objected to the higher debt, this would be the time to make legislators go on record—when they could actually change course—not years later when the Treasury has to borrow the additional money to pay the bills Congress created.

Beyond that fix, the counter-productive debt limit should be abolished. Yes, the debt can increase from factors other than fiscal legislation—for example, an economic downturn could reduce revenues below projections and increase mandatory spending. But that would be a terrible time for fiscal belt-tightening.

The toddler needs to go potty before putting on his snow suit and going outside. And Congress needs to authorize debt before it votes for the spending or taxes that will add to the debt. In both cases, failure to foresee inevitable consequences can produce a stinky mess.

https://www.taxpolicycenter.org/taxvox/congresss-debt-limit-problem-toddler-fiscal-policy