Biden and McCarthy reach a final deal to avoid US default and now must sell it to Congress
The Biden Administration Reduced the Debt-to-GDP Ratio in the Worst Possible Way
“Public debt since 2020 has grown by $3 trillion. According to the latest Monthly Treasury Statement, government spending in March of 2023 alone was twice the revenue collected. The deficit in the first six months of FY 2023 is about 80 percent as large as the deficit for the entire FY 2022. Our mid-year deficit is $1.1 trillion, compared to $667 billion at the same point last year. Falling revenue collection is responsible for only 17 percent of this difference. The other 83 percent is overwhelmingly due to excessive and increased spending.
In simpler terms, the decline in the debt-to-GDP ratio cannot be attributed to spending cuts, even as we move away from what’s now widely regarded as an excessive fiscal response to the pandemic.”
“Government debt as a share of the U.S. economy is falling.”
“The main driver behind the reduction is inflation”
The Debt Ceiling Fight Is a Reminder of America’s Dire Fiscal Future
“The debt ceiling standoff has people concerned about what will happen if the U.S. defaults on its debt. I certainly hope both sides will come together to avoid this outcome. But it is still worth reminding everyone how incredibly precarious the status quo is, and why something needs to change.
You’ve heard the warnings about our debt levels, to the point where they might be easy to tune out. I make these all the time. When assessing how much we should worry, it’s wise to look both at our current situation and where we’re heading. This year, our budget deficit will likely be $1.4 trillion. What’s more, the deficit will reach about $2.8 trillion in 2033. And that’s assuming peace, prosperity, relatively low interest rates, no new spending, and that some provisions of the 2017 tax cuts will expire as scheduled.
That’s $20 trillion in new borrowing over 10 years. So far, Uncle Sam has “only” accumulated $31 trillion in debt over the course of our entire history. But it gets worse fast. Congressional Budget Office projections show that the federal government will accumulate about $114 trillion in deficits over the next 30 years, which would place our debt at nearly 200 percent of gross domestic product (GDP). Most of this predicted shortfall is due to Social Security and Medicare. Together these programs will consume 11.5 percent of GDP by 2035.
This is a lot of borrowing. In theory, it might not lead to a debt crisis if the government can find people to buy the debt at low rates or Congress develops a serious plan to repay it. Yet even assuming the best case scenario, borrowing like this has a cost. Debt is a drag on economic growth, which means less tax revenue to pay it off.
A large debt also means higher interest payments. We already spend more on interest payments than on Medicaid, and 17.4 percent of our revenue goes toward interest payments. These payments will balloon to $1.5 trillion, or 22 percent of federal revenue, by 2033. Within 30 years, interest payments will consume half of all tax revenues. By then a lot of the spending that people like will be crowded out.
Even these estimates are rosy. They don’t take into consideration the inflation that could result from all this debt accumulation. Most of our debt has a maturity of less than four years. As Congress gives up on controlling debt, once-confident investors might worry that the Fed will stabilize the debt with inflation. History provides some examples, and today’s debt-to-GDP has fallen since the pandemic in part due to inflation. Investors, sooner rather than later, could demand higher interest rates as an inflation premium.
Research confirms the impact of debt on long-term interest rates. Every percentage point increase in the debt-to-GDP ratio is associated with an increase of three basis points (0.03 percent) of the long-term real interest rate. So, if the debt ratio rises by 100 percent over the next 30 years, it will put upward pressure on interest rates of about three percentage points.
Because of the dollar’s unique role in the global economy, the United States may have more legroom than other countries. Still, it’s wise to worry that if the debt-to-GDP ratio rises from 94 percent to roughly 200 percent in three decades, we could face some serious interest rate hikes.
If interest rates rise by just one percentage point, that will add $3 trillion in interest payments over 10 years, on top of the $10 trillion we’re already scheduled to pay. That’s an additional $30 trillion over 30 years. Add a few more interest rate hikes and soon all your tax revenue is consumed by interest payments, not to mention the negative impact these rate hikes can have on the larger American economy.
A better question is this: Is it credible to bet on investors agreeing to buy $114 trillion in debt over the next 30 years? China and Japan have already reduced their holdings of American bonds, while the Fed already holds 25 percent of our debt. It’s unclear that domestic investors will step up to the plate. What happens then? Taxes can only be raised so much. Under the current tax system, on average, the United States has raised about 18 percent of GDP in tax revenue. But in 30 years, spending will be 30 percent of GDP.
My hope is that if you’ve read this far, you now understand that Congress should start working diligently to stop our debt from growing. No side is going to like what’s required, but it must be done. And the longer we wait, the more painful it will be.”
How the White House sees its debt ceiling standoff with McCarthy
“Republicans, Biden asserted Wednesday, “say they’re going to default unless I agree to all these wacko notions they have. Default. It would be worse than totally irresponsible.”
He reminded McCarthy of the GOP’s hypocrisy — they had no problem raising the debt ceiling three times during the Trump presidency — and of Ronald Reagan and Donald Trump’s own comments decrying debt limit brinkmanship as reckless. Biden also urged the speaker to “take default off the table, and let’s have a real, serious, detailed conversation about how to grow the economy, lower costs and reduce the deficit.”
According to two people familiar with the administration’s strategy, it’s not clear to anyone inside the White House if McCarthy has the votes from his own caucus to pass his bill, and it may not yet be clear to the speaker himself, who has what one person familiar with the White House’s thinking termed a “principal-agent problem.”
The bill would be dead on arrival in a Democrat-controlled Senate. But the White House is signaling clearly to GOP moderates in the House: Vote to cut popular programs, including Social Security and Medicare, at your own risk.
“If they pass this, we are going to hang it around their moderates’ necks,” said one person familiar with the administration’s thinking.”
“Biden, his aides say, learned from the Obama administration’s 2011 standoff with Republicans that it’s imperative not to allow the debt ceiling to become part of negotiations. But with McCarthy’s tenuous speakership constantly hanging by a thread, and dependent in large part on his ability to placate his most extreme members, the White House knows that talking him off the ledge on risking default — giving up what he sees as his main point of leverage — won’t be easy.
And as much as White House officials like the politics of the negotiations’ current phase, they know they, too, will face pressure to negotiate the closer they get to D-Day.”
Pentagon chiefs: Debt default is bad for troops, good for China
““China right now describes us in their open speeches, etc., as a declining power,” Milley said. “Defaulting on the debt would only reinforce that thought and embolden China and increase risk to the United States.”
Austin added that a default would mean a “substantial risk to our reputation” that China could exploit.”
Why the debt ceiling problem never goes away
“The reason Congress continues to land in the same place is that raising or suspending the debt ceiling, much like funding the government, is something it must address on a regular basis. Every few years or so, Congress has to either increase or suspend the country’s debt ceiling as it accrues more debt. This debt comes from covering government expenses including paying for the military, health care programs, and Social Security.
If it fails to address the debt ceiling, Congress would ruin the US credit rating and put its ability to pay its bills in doubt. That would likely trigger a domestic economic crisis, if not an international one. Were the US to default, interest rates would probably go up and unemployment would increase, potentially putting thousands or even millions of people out of work.
Because it’s must-pass legislation and requires the backing of both chambers, the party that’s out of power in the White House or in the minority in Congress has often used this measure as leverage to extract policy concessions or send a political message. That has erased any incentive to reform the process, even though Congress could do away with the debt ceiling if it wanted to.”
“In recent years, Republicans have been more aggressive in demanding concessions from Democratic administrations in exchange for their support for a debt ceiling increase, though both parties have utilized such votes in the past to make a point. That’s left the US in a dangerous cycle in which the minority party tries to squeeze every concession it can out of the process, debt ceiling negotiations go down to the wire, and any miscalculation on the part of lawmakers could inadvertently cause a default.”
“the United States is unique in having a debt limit that lawmakers need to suspend or raise every few years.
A debt limit was first established in 1917 in order to “make it easier to finance mobilization efforts in World War I,” per the Brookings Institution. That enabled the US government to take on debt without Congress approving each individual expenditure, which meant it could more quickly and efficiently finance the military. Since the 1960s, Congress has raised the debt limit more than 70 times; 20 of those times have been in the last 23 years. The debt limit effectively caps how much the US is able to borrow from federal agencies, foreign countries, and banks, so if the country defaults, it isn’t able to pay its bills.”
“The US government doesn’t have to work this way.
Congress could pass legislation doing away with the debt ceiling, and the president has options to ignore it as well, though they’d likely prompt legal challenges. As Vox’s Dylan Matthews has reported, the president could invoke the 14th Amendment and ignore the debt limit, or Congress could approve an increase to the debt cap that’s so high it basically nullifies the ceiling.
Abolishing the debt limit altogether would prevent either party from using this process as political leverage. Doing so would greatly reduce the uncertainty that comes around every time there’s a deadline like this and prevent significant market volatility that results.
“There are zero downsides to getting rid of the debt ceiling. It is utterly meaningless as a policy guide or institution; it is good only for gridlocking government. And, in the modern age, gridlock is an enormous problem, given the huge pressing needs policymakers should be addressing,” said the EPI’s Bivens.
Other economic experts note that eliminating the debt ceiling could take away an opportunity for Congress to debate fiscal policy. But many feel like that’s a moot point, given debt ceiling standoffs are rarely about any specific spending anymore, but rather about weakening the party in power.”
“It’s unlikely there’s enough political will to make any of these changes happen. Instead, it seems as though lawmakers are comfortable getting right up to the brink — and running the risk of a default again and again.”
The lessons of the 2011 debt ceiling crisis, explained by the negotiators who were there
“The legislation, known as the Budget Control Act of 2011, initially increased the debt ceiling by $900 billion and guaranteed a similar amount in long-term savings across defense and non-defense expenditures. It also set up a super committee of lawmakers who were tasked with finding a set amount of additional spending cuts by late November, or automatic spending cuts would be triggered across the board.
By the time the bill passed, however, some of the economic damage was already done. Because the US was so close to default, the stock market had already dipped and the cost of borrowing had increased for the government as well. Higher borrowing costs effectively mean the government has to pay more for loans and has fewer resources to spend on public investments like infrastructure. Additionally, in part due to the brinksmanship involved, the credit rating agency S&P downgraded the country’s credit rating for the first time in US history, signaling to potential buyers that taking on US debt wasn’t as safe as it once was, and undercutting global trust in the country’s economy.
The outcome in 2011 revealed that even getting close to a default was dangerous and had a problematic impact on the economy, experts say. “This is an entirely human-made crisis that adds extra cost to the taxpayer, that can lead to market volatility, and that’s totally avoidable,” said David Vandivier, a former Treasury Department official.
“Repeating it doesn’t make sense,” emphasized Furman.
That warning may go unheeded, however. While Democrats have argued that the debt ceiling — which covers debts the US government has already incurred — should be separate from negotiations on the budget and spending, Republicans have indicated that they’re eager to use this opportunity to secure possible savings, even if it incurs risks that became apparent in 2011.”
Why Joe Biden won’t negotiate on the debt ceiling
“President Joe Biden and his staff have said repeatedly he is willing to sit down with House Speaker Kevin McCarthy to negotiate a compromise on government taxes and spending.
Biden has also said, repeatedly, that he is unwilling to negotiate over raising the debt ceiling.
These things may seem contradictory. They are not, and the somewhat subtle distinction between the two is important for understanding what is happening in Washington, DC, this summer.
Congress has two important deadlines coming up.
One is the day that the US officially hits the debt ceiling, and cannot borrow more money from bond markets without further congressional authorization.
We don’t know when that day will be, exactly — but we have a guess. In a Monday letter to McCarthy and other lawmakers, Treasury Secretary Janet Yellen said that “our best estimate is that we will be unable to continue to satisfy all of the government’s obligations by early June, and potentially as early as June 1” without a debt ceiling increase.
Once we reach that date, the federal government will not be able to pay its bills, or for things like Social Security checks, payroll for service members and other federal employees, and Medicare reimbursements. Interest payments on past debt could go unpaid, which would mean the US government would default on its debts.
The US would almost certainly enter a recession, probably a quite severe one, and the whole world could face a massive financial crisis. Beth Ann Bovino, chief US economist at Standard and Poor’s, was hardly alone in 2017 when she predicted that “the impact of a default by the U.S. government on its debts would be worse than the collapse of Lehman Brothers in 2008.”
The second deadline is September 30, 2023, the date that funding for the federal government runs out. If Congress does not pass funding bills lasting beyond that date, then on October 1, the federal government will “shut down” as it has done many times before, with many federal employees going without pay and “non-essential” services shutting down, but ordinary operations like Social Security, Medicare, and the military continuing.
Biden is willing to negotiate over the latter. He is not willing to negotiate over the former, as he reminded everyone anew in his invitation to congressional leaders for a May 9 debt ceiling discussion at the White House.
Whether he and McCarthy can navigate those distinctions and negotiate in good faith will likely determine whether the US tips into crisis in the next few months.”
“Biden’s principled case against bargaining over the debt ceiling is that doing so is effectively bargaining over policies Congress has already passed.
When Congress passed an omnibus spending bill in December 2022, it authorized specific amounts of funding for the rest of the fiscal year, which ends on September 30.
Congress has also, through literally hundreds of bills over the years, dictated the levels of tax on personal income, corporations, payroll, tobacco, etc. The revenue from these taxes do not come close to paying for the spending Congress has also authorized — meaning it has to borrow to pay for its obligations.
So the White House sees a debt ceiling bill as simply Congress agreeing to pay for spending it’s already approved, and obeying the 14th Amendment’s dictate that the federal government must always pay its debts.
“Like the President has said many times, raising the debt ceiling is not a negotiation; it is an obligation of this country and its leaders to avoid economic chaos,” press secretary Karine Jean-Pierre explained in January. “Congress has always done it, and the President expects them to do their duty once again. That is not negotiable.”
By contrast, arguing over the budget is arguing over future spending, which is a proper thing for the White House and Congress to debate with each other.”
Social Security Will Be Insolvent by 2033
“If nothing changes, Social Security benefits will be subject to a 23 percent cut in a decade.”
“Since any changes to shore up Social Security’s bottom line will likely require huge tax increases or changes to how benefits are paid, policy makers are also running out of time to implement those changes in ways that don’t cause major disruptions to the economy and Americans’ retirement plans.”
“The most straightforward solution to Social Security’s problem is to raise the payroll taxes that fund the program to make up for the shortfall on the benefit side of the ledger. But that would only exacerbate the problem by placing a bigger burden on younger, generally poorer workers.
According to the report, Social Security could be kept afloat for the next 75 years by hiking the payroll tax by 4.15 percentage points in 2034 (or implementing a smaller increase sooner). The payroll tax is currently charged at a 16.5 percent rate, with employers and employees each covering half. That works out to a nearly 25 percent tax hike. Alternatively, the report says, benefits could be cut by about 25 percent.”
LC: We could also fund it by higher taxes on the wealthy.