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.