For the third time in as many years, Congress and the White House are watching the fuse burn closer to the debt limit. Their current standoff shut down the government. If time runs out as scheduled on October 17, default will set off dire consequences for the economy – spiking rates on treasuries and mortgages, cuts or delays in crucial programs, and turmoil unseen since the financial crisis five years ago.
This debt limit showdown is a miserable debate about an issue that nonetheless could benefit from some discussion. Although we face no impending debt crisis, the Congressional Budget Office projects that under realistic assumptions, debt will start climbing significantly, and permanently, from the end of this decade into perpetuity.
Republicans and Democrats – and more importantly, the country as a whole – would benefit from a debate over a debt limit that improves our fiscal outlook. But the debt limit we have is a bad statistic (absolute debt figures) paired with an even worse enforcement mechanism (outright default). The right debt limit would establish an accurate fiscal target and credible but not catastrophic penalties for falling short. And an agreement to shift to a better measure could provide a face-saving way for both parties to escape from the current stalemate that is threatening default and shutting down the government.
The Right Ceiling
When the Congressional Budget Office, deficit commissions like Bowles-Simpson and business leaders like Warren Buffett about fiscal sustainability, they refer to debt as a share of the economy or GDP. So do the President’s budget and the House Republican budget.
The current debt limit caps borrowing at an arbitrary amount of $16.7 trillion. The absolute debt level isn't a good measure of a nation’s budget picture, because it does not take into account the size of the economy that is paying the debt. The U.S. will rack up almost two times Greece’s economy in debt this year. But while Greece has to pay 10% interest to get investors to buy its bonds, our interest rates touched historic lows. Our economy is larger and stronger, and the U.S. debt-to-GDP ratio is around 75%, while Greece’s is twice that much at over 150%.
Debt-to-GDP also rewards policies that boost economic growth and drive down the ratio, which should be appealing to both parties. Even if tomorrow's Congress agreed on a solution to cut the annual deficit and speed growth, we’d still hit the current debt ceiling’s absolute cap.
If Congress and the president can find common ground on a more accurate target, they would also have the chance to design a more responsible enforcement mechanism if it were breached. Default isn't just dangerous. It destroys faith in government financing, the very thing that the debt ceiling is supposed to protect. When we approached the debt limit in 2011, the Government Accountability Office found that “uncertainty in the Treasury market…led to higher Treasury borrowing costs,” adding more than a billion dollars in extra debt that year. Defaulting on our obligations for the first time would surely cause more uncertainty and could raise borrowing costs permanently, adding billions more to our debt.
A more responsible way to enforce the new debt limit would trigger spending cuts and/or revenue increases when debt-to-GDP ratio officially crossed a new threshold.
In fact, the Administration put forward this type of target in a quickly-forgotten proposal to the "Supercommittee" in September 2011. This plan would have required the government to act sensibly to pay down the debt and reduce the debt-to-GDP ratio in economic expansions, and made exceptions to allow for spending in response to an economic downturn or national security crisis.
After all, sometime you need debt to bail out a weak private sector, just as this government (and the previous government under Bush) did in response to the crisis. Today's blunt debt-ceiling instrument can't distinguish good debt from bad debt. But a better debt limit could.
A Way Out
Both parties would no doubt argue over the target and enforcement mechanism. Republicans would want a low target and cuts to back it, while Democrats would want a higher target enforced by a combination of revenue and spending reforms. But having this debate is far better than the debate we are having now over a flawed measure and the threat of a default.
This alternative could provide upsides for both parties that would let them out of their current standoff.
Republicans in Congress are taking a big gamble. They could succeed in their goal of deep cuts or rolling back Obamacare by shutting down the government and threatening default. This approach may have worked in 2011 to secure the current sequestration cuts. But earlier this year, after the President was re-elected and business leaders awoke to the possibility that Republicans were serious in letting the fuse run out, they agreed to a debt limit increase with little fanfare.
Instead of an all-or-nothing stand, Republicans in Congress could have a better chance of achieving fiscal responsibility by debating over a more accurate debt measure, and enforcement that rewards growth. And they will avoid setting an irresponsible precedent – imagine Democrats refusing to raise the debt limit over background checks for guns under President Christie or Rubio.
The president and Democrats would welcome removing the threat of default, and instead having a debate over a more accurate measure of debt and policies to enforce it. The economy can benefit from a debt limit that actually measures our debt burden and keeps it sustainable – but that’s not the debt limit we have today.