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What’s the debt ceiling? The legal limit on borrowing by the federal government. Before 1917, Congress had to approve borrowing each time it came up. In order to allow for more flexibility as the nation entered World War I, lawmakers agreed to give the federal government blanket approval for most types of borrowing — as long as the total was less than an established limit. Why is this an issue now? The nation’s debt is inching closer to the legal limit of $14.3 trillion. According to Treasury Secretary Timothy F. Geithner, the ceiling could be breached as soon as May 16, though the government could take unconventional measures such as halting contributions to pension funds to delay that point until July 8. What happens if the debt ceiling is breached? If Congress does not increase the limit, borrowed funds would not be available to pay bills and the United States may be forced to default on its debt obligations. There’s no precedent for this situation. Treasury has never been unable to make payments as a result of reaching the debt limit. With a fragile global recovery counting on U.S. economic stability, the debt limit issue could roil international financial markets. Democrats and Republicans agree that if the debt limit is not raised we would be inviting economic catastrophe. So if both parties agree, why not just raise the limit? What is everyone arguing about? In the past, raising the debt ceiling has mostly been a perfunctory matter. The ceiling has been raised almost 100 times since it was established and has gone from less than $1 trillion in the 1980s to $6 trillion in the 1990s. The most recent time the ceiling was boosted was in February 2010. Legislation to raise the debt limit usually prompts partisan posturing about fiscal responsibility, but little real drama. This time is different. With the national debt at its highest point in 50 years compared with the size of the U.S. economy, the debate about the ceiling has become entwined in the larger issue about slashing the budget. The budget debate is shaping up around trying to balance two perhaps equally unpopular remedies: sharp cuts to popular government-funded programs and major tax increases. Republican lawmakers say that if they raise the limit they need a commitment from the White House for more spending cuts. The Obama administration has resisted the idea of including spending caps or other budget-process reforms in legislation to raise the debit ceiling, arguing that ensuring the government’s solvency is too important to be held hostage to other issues. What happens if we don’t raise the debt ceiling but continue to pay interest on our bonds?This is an option known as “prioritization.” The Bipartisan Policy Center released a report attempting to think through how this would work in practice, as it has never been attempted before. The raw numbers are chilling: In August, the federal government would have to cut expenditures by about $134 billion, or 10 percent of the month’s GDP. If it chose, for instance, to fund Medicare, Medicaid, Social Security, supplies for the troops and interest on our bonds, it would have to stop funding every other part of the federal government. The drop in demand, when coupled with the turmoil in the markets and the general financial uncertainty, would undoubtedly throw the economy back into a recession. Also keep in mind that we have to roll over $500 billion in debt that month, and if there was uncertainty about how we were going to pay our bills, it is not clear we could find buyers for our debt at anything less than an exorbitant rate. In this way, “prioritization” could actually increase the deficit. What happens if we stop paying the interest on our debt? This is too scary to consider for any serious length of time. Treasury securities sit at the base of the global financial system. They are considered so safe that the interest rate on Treasuries is called the “riskless rate of return,” as the market assumes there is no chance of default under any circumstances. Almost all other types of debt — mortgages, credit card, auto loans, business loans, hospital bonds, etc. — are yoked to Treasuries. Almost all major financial players hold substantial portfolios of Treasuries or Treasury-related debt in order to buffer themselves against financial shocks. Consider that the 2007 financial crisis was caused by the market realizing it had to reassess the risk of bonds based on subprime mortgages. If the market has to reassess the risk of Treasuries, the resulting financial crisis will be beyond anything we’ve ever seen in this country. What happens if Congress fails to raise the debt limit and the U.S. can no longer make payments on its obligations? How much money are we talking about? Under the spending plan President Obama submitted to Congress in February, lawmakers would have to raise the limit by nearly $2.2 trillion just to see the nation through next year. Under the more austere blueprint that House Republicans approved last week, the government would require about $1.9 trillion in fresh debt by October 2012 — a month before the next presidential election. Why does the United States have so much debt anyway? There are numerous reasons. Here are some major ones: Under President George W. Bush, the national debt soared to $4.36 trillion because of the cost of wars in Iraq and Afghanistan and new tax cuts, and again under Obama, an additional $3.9 trillion, because of the economic stimulus and decreased tax revenue during the recession. Do we need a debt ceiling? Strictly speaking, no. The debt ceiling is unique to America. In other countries, when the legislature passes a law, the Treasury is given automatic authority to carry it out. A number of former Treasury Secretaries have said it should be abolished, including Larry Summers, who said, “I think that given that Congress has to approve all spending and all tax changes, there is not much logic to the debt ceiling.” Does the debt ceiling reduce deficits? In general, no. The nonpartisan Congressional Budget Office examined this issue and concluded (pdf) that “setting a limit on the debt is an ineffective means of controlling deficits because the decisions that necessitate borrowing are made through other legislative actions. By the time an increase in the debt ceiling comes up for approval, it is too late to avoid paying the government’s pending bills without incurring serious negative consequences.” Is the debt ceiling unconstitutional? A number of commentators have suggested that the 14th Amendment, which states that “the validity of the public debt of the United States ... shall not be questioned,” renders the debt ceiling unconstitutional. Others have disagreed, including Lawrence Tribe, a professor of constitutional law at Harvard, who notes that the Constitution gives Congress the sole power “to borrow money on the credit of the United States.” Ultimately, this point is probably moot, at least for the time being, as the Treasury Department has stated that it agrees with Professor Tribe’s interpretation. If you thought the financial crisis was bad, wait till the debt ceiling caves in Timothy Geithner does not want the market to smell his fear. “I want to make one thing perfectly clear,” he said Sunday. “Congress will raise the debt ceiling.” But if there was truly so little doubt, Geithner wouldn’t have been peppered with questions about it on the Sunday shows. Raising the debt ceiling may be economically necessary, but it’s politically lethal. Only 16 percent of Americans want the debt ceiling raised, according to an NBC/Wall Street Journal poll. Sen. Marco Rubio said he wouldn’t vote for an increase unless it included “a plan for fundamental tax reform, an overhaul of our regulatory structure, a cut to discretionary spending, a balanced-budget amendment, and reforms to save Social Security, Medicare and Medicaid” — everything on the conservative agenda, basically. And this is where things get dangerous. Republicans and Democrats both bear substantial blame for the country’s rising deficits. The Bush tax cuts and the Medicare Prescription Drug Benefit and our various wars — none of which have been paid for, and all of which are ongoing — are major contributors to our mounting debt, and all were passed by Republican majorities. The debt ceiling had to be raised seven times during the Bush years, and the policies that helped drive those increases — not to mention the financial crisis that followed them — have not been undone under Obama. But the GOP wants to pin the debt on the Democrats, and it wants major concessions in return for its vote. Democrats, however, aren’t going to agree to the GOP’s plan to deny partial responsibility for the country’s debt and hold the country’s credit rating hostage in order to reshape the government along more conservative lines. Fear over exactly this sort of political gridlock is what led Standard & Poor’s to downgrade the nation’s credit outlook to “negative” Monday. To understand the danger posed by the debt ceiling, it helps to understand the financial crisis. A lot of banks and investors held assets based on mortgages they thought were safe. They weren’t. That meant that no one knew how much money they really had, or how much money anyone else really had. So the market did what woodland creatures do when they get confused and scared: It froze. And so, too, did the economy. As the unemployment rate shows, we’re still not completely thawed out. If Congress fails to lift the debt ceiling beyond its current limit of $14.29 trillion — or even waits too long — the chain of events will be similar, but the asset under question will be America itself, not some newfangled Frankenstein bond made out of mortgages from the Reno suburbs. Which would mean the aftermath would be much, much worse. “The cornerstone of the global financial system is that the United States will make good on its debt payments,” says Mark Zandi, chief economist at Moody’s Analytics. “If we don’t, we’ve just knocked out the cornerstone, and the system will collapse into turmoil.” Throughout the financial crisis, America’s great advantage was its status as the single safest investment in the world. That makes it easier for us to borrow money to ease a downturn. It makes it easier for our central bank to buy bonds to keep interest rates low. It gives us tools and flexibility that, say, Greece simply doesn’t have. But all of that is based on the market’s perception that our debt is, indeed, a safe investment, that we will pay it back, that we won’t inflate our way out of the fiscal holes we dig, that our political system will make tough decisions when necessary. Confidence, once lost, is hard to regain. “It’s like a cat who jumps on a hot stove,” says Bill Gross, co-founder of Pimco. “Burn it once, and it doesn’t jump back on there.” Gross, incidentally, not only thinks the stove is getting pretty hot, but his firm is turning up the gas: Pimco is now betting against Treasurys. If he’s right, however, and the various foreign and domestic investors buying and holding Treasurys end up getting less than they were expecting, or undergoing a lot of strain and anxiety while Congress dithers, they’ll probably start putting their money elsewhere. At that point, the “then what” looks pretty scary. Balancing our long-term budget won’t be easy. But it’ll be much harder if rising interest rates become a noose on the recovery. “Once the interest rate starts to rise, the ballooning of the interest-carry cost on this debt will scare the bejeesus out of the system, and it’ll be a feedback loop into the market,” says David Stockman, who served as Ronald Reagan’s budget director. In other words, the more the market worries about our ability to repay our debt, the harder our debt becomes to pay back. High interest rates slow economic growth and increase the amount we have to pay to borrow, both of which mean our debt grows as a percentage of our economy. Which gets to the essential irony of this whole conversation: By taking the debt ceiling hostage in a bid to address the deficit, Congress could provoke the exact calamity it’s seeking to prevent. What we worry about when we worry about the deficit is that the market will lose confidence in our ability to pay back our debts and begin charging more to buy Treasurys. There’s no quicker way to undercut the market’s confidence in the U.S. government than for it walk up to the abyss of default. The likeliest disaster here will not be caused by Congress refusing to raise the debt ceiling. And, Geithner says, Congress will raise the debt ceiling. Eventually. But there’ll be a lot of partisan posturing between now and then. In 2006, then-Senator Barack Obama lodged a protest vote against an increase in the debt ceiling — a vote he’s since called “a mistake.” Our economy, however, is weaker than it was then, our deficits are more worrying and the markets are more fragile. So the normal congressional bickering could prove especially dangerous. Earlier this month, Congress waited until the last possible minute to avert a shutdown — waited so long, in fact, that the government was technically unfunded for a few moments — and we could see it wait till the last minute on the debt ceiling. But the last minute might be too late. “The risk is not that we get to July and run out of desperation measures,” says Citigroup’s Peter Orszag, who previously served as Obama’s budget director. “Both political parties realize that would be crazy. But the worry is you’re in June and you think you have time and the market blows apart early.” In the end, the debt ceiling is not just about the debt ceiling. It’s about our capacity to solve our economic problems going forward. If the two parties can come to a grand bargain on debt and deficits by the end of May, then great. But if they can’t — and that’s where the smart money is — the debt ceiling is not the moment to demonstrate to the markets that Washington is broken. Once we pull the pin on that grenade, there’s no putting it back in. Expenditure cuts could save billions, but to GOP it’s all code for tax increase By Ezra Klein, Published: July 21 I spent time digging through the federal budget this week, and I concluded that Republicans are right: There is plenty of spending to cut. For instance, we’ve got one government program that hands people money to buy houses that, in most cases, they would buy anyway. They get even more money if they buy a more expensive house. Over the next five years, that program alone will cost almost $500 billion. Another federal agency will spend more than $400 billion to reward people for making money by investing and earning capital gains and dividends rather than by going to work and taking their income in wages. I like investors and I participate in the market, but is this really the sort of activity that requires a $400 billion subsidy? $14.3 trillion is a massive number. Here are some figures that put it in perspective. Here’s one I can’t figure out: Why are we sending checks to employers who subsidize their workers’ transportation costs? Is there some reason we want transportation to be included in an employee’s compensation package? Do we want it to the tune of more than $20 billion between now and 2015? And did you know that every time someone makes a charitable donation, the federal government transfers money into the donor’s bank account? Supporting shelters and museums and Doctors Without Borders is a good deed and all, but is it really something that taxpayers should reward with more than $200 billion in cold, hard cash? There is tons of this stuff. The government pays employers $700 billion to offer health insurance to their employees, which no economist would say is a good idea. We’re subsidizing select parts of the energy sector, spending almost $2 billion, for instance, to subsidize “open-loop biomass” rather than simply pricing carbon emissions and letting the market work out the details, and we’re handing $4 billion to oil and gas companies that explore for new reserves. Midway through my excavation, however, when I was really just getting warmed up, I realized I had made a mistake. I wasn’t looking at the federal budget — I was looking at the U.S. tax code. So cutting all those costly programs wouldn’t count as cutting spending to Republicans in Washington. It would count as raising taxes. All those programs are tucked in the tax code, classified as “tax expenditures.” Like traditional government spending, the point is to achieve specific ends by throwing money at a problem. The only difference is that the beneficiaries don’t receive checks from the government, they simply have their tax liabilities reduced. The Center on Budget and Policy Priorities estimates that, in 2010 alone, tax expenditures cost the government more than $1 trillion — more than Medicaid and Medicare combined. These tax expenditures have emerged as the central sticking point in budget negotiations. Democrats want new revenue to be part of the deal, but because Republicans adamantly oppose raising marginal tax rates, Democrats have instead proposed cutting expenditures by about $1 trillion. They thought that would be more palatable to Republicans, but thus far they’ve been wrong: Republicans say that increases in revenue are increases in taxes. It doesn’t matter whether the money comes from closing loopholes or raising rates. Some of their brightest policy lights, however, disagree. Former Federal Reserve chairman Alan Greenspan says that tax expenditures are “misclassified” because they are identical to outlays. Gregory Mankiw, who led President George W. Bush’s Council of Economic Advisers, calls expenditures “stealth spending implemented through the tax code.” You can’t find a serious economist on God’s green Earth who thinks the economy differentiates between cutting a government program that subsidizes health insurance and cutting an equally large tax break that subsidizes the purchase of health insurance. The crude budget calculus that counts every dollar in spending cuts as a win for Republicans and every dollar in revenue increases as a win for Democrats is simply wrong. There are tax expenditures that Democrats aggressively protect — like the Earned Income Tax Credit, which provides a huge lift to low-income Americans. And there are spending programs that many Democrats oppose, including quite a few run out of the Pentagon. On average, tax expenditures are regressive. So if you’re cutting them across the board, you’re raising taxes in a relatively, though not exclusively, progressive way. Yet partisan negotiators in Washington aren’t likely to cut tax expenditures or taxes across the board. They will start with vague targets and eventually advance specific cuts and reforms. And that’s when we’ll know how much of the deal should be counted as spending cuts and how much as tax increases — and whether, in the final analysis, that distinction even matters.
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