Raise the Debt Ceiling, Protect our Communities
Edith Rasell, Minister for Economic Justice
In the midst of our severe, prolonged economic downturn, the federal government is borrowing money to pay its bills and meet its obligations. By law, Congress sets the limit (ceiling) on the amount of money the government may borrow. If it is to continue to function, Congress must increase the government’s debt limit before August 2.
The consequences of inaction are dire. On July 14,
2011, Federal Reserve Chairman Ben Bernanke testified before the Senate Banking
Committee that failure to raise the debt ceiling before the August 2 deadline
would be “calamitous” and “create a severe financial shock.”
Raising the debt ceiling is essentially a book-keeping task. It does not change federal spending. At this time, the budget for the federal government is set through the end of September, 2011. In the coming months, Congress will pass a budget for the next fiscal year, October, 2011, through September, 2012. Raising the debt ceiling does not affect these budgets, increase spending, or change the size of the deficit.
Some members of Congress are refusing to support an increase in the debt limit except as part of a package that includes huge spending cuts. These reductions in spending, if they follow the pattern established in the House of Representatives’ recent budget proposal, would target programs for low- and moderate-income people and essential government functions. The cuts would further harm people who are already suffering and prolong (and possibly worsen) the economic downturn.
Any conditions that are attached to an increase in the debt ceiling should target reductions in the deficit, not just cuts in government spending. Shrinking the deficit must be done through both spending cuts and tax increases on wealthy households and corporations. Tax increases must be part of any effort to reduce the deficit, not just spending cuts.
Wealthy households have done extremely well over the last 40 years and should pay more taxes. Over the last four decades as the economy has grown and national income has risen, average income among the bottom 90% of households has fallen slightly. All the gains went to the top 10%, primarily the top 1% who have seen their incomes grow three-fold after adjusting for inflation: from $379,021 in 1970 to $1,137,684 in 2008. If the growth had been shared, every household in the bottom 90% would be receiving nearly 30% more income. Instead, the rich have gotten richer, the poor have gotten poorer, and everyone else has received crumbs. But as wealthy households saw their incomes skyrocket, their taxes were cut. Now, their taxes should be raised.
Corporate taxes also must be increased. Over the decade of the 1950s, taxes paid by corporations averaged 4.8% of gross domestic product. In the 1960s, the share fell to an average of 3.8%. In the 1970s it fell farther to 2.7% and over the 1980s it went down to 1.7% where it has remained ever since. It is time to raise taxes on corporations, close loopholes, and go after tax avoiders.
Congress must raise the debt limit. This should happen without strings or conditions. But if some members of Congress demand spending cuts as a condition of their support, then tax increases must also be part of the mix. Any effort to reduce the deficit must rely on both spending cuts and tax increases.
What is the government debt and how is it related to the deficit?
Like many households and businesses, the federal government borrows money. Whenever the federal government spends more than it takes in, the budget is in deficit and borrowed money makes up the difference. The government borrows money from individuals, businesses, and other governments by selling Treasury bonds.
The government debt is the total of all the deficits accumulated over time minus any that have been paid off. In recent decades, the federal government has run a deficit nearly every year. The only exceptions were the four years starting during President Bill Clinton’s second term of office in the mid-1990s when the budget was in surplus and the country paid off some of its debt.
During difficult economic times, the government needs to run a deficit. Extra government spending boosts purchasing so firms need to produce more and hire extra workers. It is also hard not to run a deficit when unemployment is high. When fewer people are employed, national income is reduced and people pay less in taxes. At the same time, government expenditures rise as more people rely on safety net programs like unemployment insurance, food stamps, and Medicaid. This creates a deficit.
Is government debt a bad thing?
As in any business or household, government borrowing is not necessarily a bad thing. It depends on what the money is used for. If the money is invested, that is, spent on things that will bring a future financial return (for example, a college education, a new factory, or infrastructure to make the economy work more smoothly) then borrowing makes sense.
As debt increases, it can become a problem. First, interest on the debt must be paid which drains money from other uses. However if the borrowed money was properly used for investments, the additional revenue flowing from the investment will be larger than the interest payment. The country will be better off because of the borrowing.
A second concern is the possibility that large amounts of government borrowing could create a shortage of investment funds for others. Interest rates would rise and loans would become more expensive for firms and households, limiting their ability to borrow and invest. But if interest rates are low, as they are now, there is no shortage of money available for borrowers.
Finally, if the debt becomes so large that investors question whether it can ever be repaid, they might require very high rates of interest to offset their risk, or they might stop lending all together. Our current very low interest rates indicate investors continue to have confidence in the ability of the government to repay its debt.
Is the U.S. debt too large?
The point at which a country’s debt is “too large” is sometimes difficult to assess but an important indicator is the interest rate. If investors begin to fear that the U.S. might not be able to repay them, then interest rates will start to rise. Currently, interest rates on government debt are close to zero. Given the high debt levels in many nations that also continue to borrow at low rates, the U.S. probably has nothing to fear for years. Worldwide, U.S. Treasury bonds are regarded as the safest asset. This has been true historically and continues to be true today.
During an economic downturn, deficits are beneficial
Running a deficit during an economic downturn is the right thing to do. Not only does it provide humanitarian assistance to ease people’s suffering, (food stamps, unemployment insurance payments, Medicaid, etc) it also helps reduce unemployment and get the economy back on track more quickly.
In our recent downturn, national income and output (Gross Domestic Product) fell and have not yet returned to their expected levels. (See the red line in the chart below from the Center on Budget and Policy Priorities) The shortfall during the past few years is a permanent loss. The income that people did not receive because they were out of work will never be recovered. The national output that was lost – the cars not produced, the college classes not taught, etc. – will never be replaced. But after a typical downturn, there is a catch-up phase. Worker’s incomes and firms’ output grow faster than usual and return to the expected level. In the chart below, notice that after downturns, actual GDP (red line) returns to (or even rises above) the level of potential GDP (blue line).
The more quickly this happens, the better for everyone. Government deficits help bring about this recovery. The sooner the economy is sound again, the sooner tax revenues recover. The deficit is an “investment” in a speedier recovery and higher tax revenues. It should pay for itself. For more on the importance of running a deficit during economic downturns see “The Federal Government Deficit: An Essential Tool for Putting People Back to Work and Ending the Economic Downturn”
What is the debt ceiling?
The debt ceiling is the maximum amount that the federal government can borrow. It sets the limit on the size of the government debt. By law, Congress sets the debt limit. If the government runs a deficit (that is, spends more than it takes in), then the debt will grow and Congress will need to periodically raise the debt ceiling. Currently the federal government is authorized to borrow a total of $14.3 trillion. That level was reached in mid-May. Since then the government has continued to pay all its bills only by shifting money among accounts to cover cash flow. Treasury Secretary Timothy Geithner estimates that, in this way, the government can continue to meet its financial obligations through August 2. But at that time, the debt ceiling will need to be increased so the government can borrow the money it needs.
What if Congress does not raise the debt ceiling?
If Congress does not raise the debt ceiling before August 2 (and probably it should happen well in advance of August 2 so as not to scare investors), it is impossible to know what might happen since the situation would be unprecedented. But two things are likely.
First, with no money the federal government would shut down (or try to continue to function on I.O.U.’s as California did earlier in 2009). Workers – everyone from members of the military to park rangers and air traffic controllers – would not be paid. Creditors would be put on hold. Whether payments for Social Security, unemployment insurance, and other essentials would be sent is anyone’s guess.
Second, the U.S. would default on its debt. It would not pay bond holders their interest or repay their principle when it was due. This would be very bad, possibly throwing global markets into chaos and sparking a very large spike in interest rates once the U.S. were able to begin borrowing again.
June 2011
