A Debt Crisis of Our Own Making

Image source: Financial Times

In mid-January, the United States once again reached its debt ceiling, creating yet another opportunity for a global financial crisis and the collapse of the U.S economy. With the Congressional Budget Office’s recent report that the U.S. could default on its debt as early as July, Americans are gearing up for an increasingly common yet perilous political battle: a debt ceiling showdown. As of now, the parties have incompatible solutions. While the G.O.P wants deep spending cuts in exchange for avoiding default, Congressional Democrats prefer a quick and unconditional increase to the debt limit. This time, with the Republicans' new House majority eager to secure a political victory over President Biden, the risks seem dangerously imminent. Although our recurrent dance with default may seem like an inevitable consequence of our increasingly polarized society, this could not be further from the case. It is the debt ceiling itself, a fundamentally flawed institution, that gives rise to these partisan crises. As Congress prepares for another high-stakes game of chicken, let’s remember that this is all avoidable. It’s time to have an honest conversation about the debt ceiling: it’s a destructive legislative mechanism, entirely arbitrary in its foundation.

The arbitrary nature of the debt ceiling is obvious when one realizes its fundamental disconnect from economic reality. Historically, Congress has raised or suspended the debt ceiling based on an incoherent combination of what the Economic Policy Institute describes as “congressional whim and partisan strategizing” (Bivens 2023). Unlike most government spending and taxes, the debt ceiling is not indexed to inflation. And worst of all, its limit is determined by gross debt.

Gross debt is a misleading measure of the national debt. It includes funds held in the Social Security Trust Fund (SSTF), which makes no sense given that the fund owes its robust surplus to American citizens (Bivens 2023). Gross debt also ignores the $2 trillion in assets held by the government, making those assets irrelevant in the eyes of the debt ceiling (Bivens 2021). If the debt limit is our most high-stakes economic indicator—capable of triggering a default—then it should at least be based on an accurate account of the nation’s finances.

By relying on gross debt to determine when the United States has hit its debt limit, the debt ceiling is capping the nominal debt held by the United States; but that numerical figure bears no relationship to the actual burden that the national debt puts on the economy. Rather, interest payments to bondholders constitute the true strain on the economy. From 1996 to 2020, these payments fell from 3% of GDP to 1.6% of GDP, easing the fiscal burden of the national debt, while gross debt increased from $5.2 trillion to $26.9 trillion (“Gross Federal Debt” 2022), forcing Congress to raise or suspend the debt ceiling 23 times (“Table 7.3”). This intrinsic detachment from economic reality makes the debt ceiling an arbitrary figure.

And yet, political battles over the debt ceiling have real-life consequences. Politicians have weaponized it to impose damaging austerity policies on the economy. The Budget Control Act resulted from negotiations to end the Republicans’ debt ceiling crisis of 2011. The BCA required that any increase in spending be matched by deficit reductions, and it automatically triggered across-the-board budget cuts if Congress did not produce legislation to reduce the deficit. This was essentially a haymaker to a hobbled economy barely able to stay on its feet. The BCA resulted in an anti-stimulus about twice as powerful as the Obama administration's Recovery Act, and a historically meek economic recovery that took 5-6 years longer than it otherwise would have (Bivens 2021). The BCA’s proponents will argue that these were necessary and responsible policies to manage a debt crisis. But the crisis itself was manufactured by the debt ceiling; no line in the sand was crossed other than the one the debt ceiling arbitrarily drew. 

The debt ceiling is not a practical solution to the U.S.’ ballooning national debt. It creates the threat of default, regardless of whether that threat is warranted, while giving irresponsible political actors the opportunity to leverage that default into economically harmful legislation. If we aren’t careful, 2011 will happen all over again this July. Clearly, the potential costs of the debt ceiling far outweigh its benefits. It’s past time it was abolished.

References

Bivens, Josh. 2021. “Abolish the debt ceiling before it commits austerity again: The GOP used the debt ceiling to force spending cuts in 2011. It can't be allowed again.” Economic Policy Institute. https://www.epi.org/blog/abolish-the-debt-ceiling-before-it-commits-austerity-again-the-gop-used-the-debt-ceiling-to-force-spending-cuts-in-2011-it-cant-be-allowed-again/.

Bivens, Josh. 2023. “The debt limit is the world's highest-stakes horoscope: Not raising the debt limit would guarantee a recession.” Economic Policy Institute. https://www.epi.org/blog/the-debt-limit-is-the-worlds-highest-stakes-horoscope-not-raising-the-debt-limit-would-guarantee-a-recession/.

“Gross Federal Debt,” Dataset. 2022. FRED. https://fred.stlouisfed.org/series/FYGFD.

“Table 7.3—STATUTORY LIMITS ON FEDERAL DEBT: 1940–CURRENT,” Spreadsheet. 2023. Historical Tables.