Today, Jim Carter and I wrote this op-ed in Investor's Business Daily. Until recently, Jim was Chief Economist at the Senate Budget Committee Minority and Deputy Assistant Secretary of Treasury.
House Speaker John Boehner has a problem. With the federal government rapidly approaching its debt limit of $14.294 trillion, more than a few members of the House have said they won't vote to increase it.
Some oppose raising it as a matter of principle. Others are willing to raise it, but only if the increase is accompanied by spending cuts and budget reforms. And then there are those who simply want to make the most of this opportunity to score political points.
For his part, Speaker Boehner understands the risks associated with not increasing the debt ceiling, calling a failure to do so "a financial disaster, not only for us, but for the worldwide economy."
We agree. Any failure by the government to meet all of its obligations would result in a lasting downgrade by rating agencies that would saddle future generations of Americans with significantly higher interest rates on newly issued federal debt.
Yet, for all the fuss over the debt limit and the potential disaster we face, this crisis is not only avoidable, it's unnecessary.
The first debt limit was established by the Second Liberty Bond Act of 1917 as Congress' condition for allowing the Treasury to sell bonds to finance World War I. The limit was raised repeatedly over the next two years by the Third and Fourth Liberty Bond Acts and the Victory Liberty Loan Act.
The Treasury had great difficulty selling enough bonds to finance the $32 billion cost of World War I, even as it raised interest rates on each successive bond issue, so the debt limit served as a cosmetic to persuade buyers that their bond purchases would hold their value.
World War II took gross federal debt from 52.4% of GDP in 1940 to a peak of 121.7% in 1946. Although the federal government ran budget surpluses in only eight of the thirty-five years that followed, those years saw a dramatic decline in the gross federal debt relative to GDP as, more often than not, annual economic growth outpaced debt growth.
By 1981, the gross federal debt had fallen to 32.5% of GDP. Nonetheless, Congress increased the debt limit dozens of times during that period because the debt continued to grow in dollar terms even as it shrank relative to GDP.
Since 1981, except for a five-year respite starting in 1997, the gross federal debt has ballooned both in dollar terms and as a share of GDP, prompting Congress to raise the limit forty more times. Gross federal debt is rapidly approaching 100% of GDP. Obviously, if the debt limit was ever intended to limit the debt, it's not working very well.
Economists generally agree that we should abolish the debt limit. Once government spending and tax decisions have been made, the only question is whether to honor our obligations.
Former Federal Reserve Chairman Alan Greenspan said as much during last Sunday's "Meet the Press."
"Why do we have a debt limit in the first place?" he asked. "We appropriate funds or we have tax law, and one reasonably adept at arithmetic can calculate what the debt change is going to be. The Congress and the president have signed legislation predetermining what that number is. Why we need suspenders and belts is something I've never understood."
Congress won't abolish the debt limit because it's a very handy must-pass piece of legislation on which all manner of amendments unrelated to the budget can ride into law and because a vote against the debt limit can give a spendthrift member of Congress the appearance of being fiscally responsible.
So if we're going to have a debt limit anyway, why have a limit that has no basis in economic reality?
The current limit covers more than 99% of total federal debt, including publicly held debt and debt held by federal accounts (e.g., the Social Security Trust Funds). The latter is just the authority, but not the means, to pay promised future benefits to ourselves. The fiscal burden of providing those benefits is not felt until the benefits are paid. So trust fund debt has no economic impact. It's just a distraction.
As we grapple with the hard work of deficit reduction over the coming years, why not exclude debt held in federal accounts from the debt limit? Given that publicly held debt is just under $9.7 trillion, the existing debt limit of $14.294 trillion could be lowered to $12 trillion, leaving enough room to accommodate the federal government's anticipated borrowing needs beyond the 2012 elections.
Congress could avoid a potentially disastrous fight over raising the debt limit, and we would focus on the debt that matters for economic growth: the debt held by the public.