I’ve been meaning to write for some time about how the debt ceiling standoff this time is going to be resolved, but now that Secretary Yellen has said the Treasury could run out of cash by June 1 and President Biden has announced that he plans to meet Speaker McCarthy on May 9, I realized that I can’t wait any longer.
No one I know (including me) expects any breakthroughs at the May 9 meeting. The House, led by McCarthy, insists on conditioning an extension of the debt ceiling through March of next year (in the middle of the Presidential primary season), tied to 10-year caps on discretionary spending (excluding “entitlement programs” Social Security and Medicare), which would rise 1% a year, on a baseline that would roll back Congressionally approved spending on both domestic and military programs in 2022. The 1% increase, meanwhile, is well below recent inflation rates of 5% and even below the 2% inflation target that the Fed presumably wants the economy to return to. Accordingly, the House caps would shrink “real” or inflation-adjusted federal spending over time, even for military spending, and thus hamstring the ability of the US to aid Ukraine and to build up preventative defenses in Taiwan aimed at deterring a Chinese attack, all the while making it increasingly more difficult for the government to enforce our laws, support scientific research, monitor the weather, operate national parks and carry out countless other domestic operations. President Biden, for his part, insists on getting a “clean” debt ceiling bill, but is willing to negotiate a deficit reduction program separately, presumably at the end of the fiscal year when appropriations are supposed to be provided – although the deficit reduction plan he has in mind, from public statements, is one that would rely only on modestly higher taxes for upper income Americans.
There is an obvious compromise to be had between these two positions, but it is not yet clear who will blink first, and when. That compromise would cap discretionary spending for just two years at levels that would ensure that inflation-adjusted spending remains flat, getting us all through the next election cycle, so that the American people – by voting for President and their Congressional representatives – can decide what spending should look like thereafter. The baseline would be just as Congress enacted it in 2022. The compromise also would not add other Christmas tree items, such as a work requirement for Medicaid recipients, that the House bill now includes, which also would be on the 2024 ballot. Such a deal would allow House Republicans to say that they had imposed some spending restraint on a reluctant Administration, while the Administration could claim that it avoided a much worse outcome, and preserved the spending for the Inflation Reduction Act and military spending that was approved in a somewhat bipartisan fashion in 2022.
I know, this sounds too rational for these crazy times, but after all the craziness we’re about to witness, this compromise is where I think we’ll eventually land. The big question is whether we’ll suffer a full-scale default, and the economic chaos (including a major stock market crash) and steep drop in economic activity (federal spending accounts for about ¼ of GDP!) for whatever period it takes for the two sides to compromise, or one side to cave in (which is what each side is now counting on, hoping that a majority of the public will blame the other side for catastrophe, if it comes).
It is possible, as some have recently speculated, that the immediate debt ceiling crisis could be avoided by increasing the ceiling to allow new debt issued through September 30th, when appropriations for discretionary spending must be authorized, or at least another Continuing Resolution (CR) passed. Doing so would put off the days of reckoning, give the Biden administration cover to say that any budget deal it negotiates – which as I suggest, is likely to end up similar to the one I have just sketched out – is being done as part of the “normal appropriations process” and not at the gun of a debt ceiling threat. My guess, and it is only that, however, is that there are enough extreme voices among House Republicans not to grant such an extension. They are spoiling for a fight, now.
If neither side blinks and the day comes in June that the Treasury says it can’t pay interest, I predict it will – notwithstanding the position that Treasury Secretaries have taken in the past that the law doesn’t allow it to “prioritize” certain obligations over others. I could be wrong: the Administration might gamble that not paying interest (let alone not redeeming Treasury bonds that come due) would trigger the kind of stock market collapse that occurred back in 2008 when Congress at first rejected the Bush Administration’s bank rescue plan – only to approve it several days later – that would drive House Republicans, or peel enough of them to side with Democrats, to pass the clean debt ceiling bill the President wants. But that’s a real gamble, because frankly, I don’t think anyone really knows who the American people would most blame if a true default were to occur. The past – when Republicans have been blamed for near defaults and government shutdowns – may not be a good guide to what happens in these times. I don’t think the Administration, when push comes to shove, wants to find out.
The next question then becomes: would the Administration allow the Treasury Secretary also to “prioritize” Social Security payments and Medicare reimbursements? Treasury has made noises that this would be impractical to do. I don’t believe it. It’s more a matter of will and political calculation – will seniors who totally depend on their monthly social security checks, in particular, blame Republicans more than Democrats, if those payments are missed? -- than monetary plumbing.
What about paying the rest of the government’s bills, payments which have already been authorized by Congress through the end of this fiscal year, or September 30! This is a more complicated question. Altogether, discretionary spending totals around 8% of GDP, so not paying government workers and contractors would be a big hit to the economy for as long as it occurs. But if the administration wanted to avoid this outcome, it could do it, and here’s how.
Given that the deficit is about 5% of GDP, then Treasury should have enough cash to pay about 3/8 of the government’s bills. For the remainder, Treasury could then issue bonds, as it normally does during deficit years. Yes, you read that right: notwithstanding the ostensible lack of Congressional authority to issue debt because the debt ceiling has not been lifted, the Administration could simply declare that the act is essentially unconstitutional, citing the 14th amendment’s language: “The validity of the debt of the U.S. …. shall not be questioned.” Then dare anyone to sue. The Supreme Court has sharply limited who has standing to challenge federal actions, including challenges by Congressional members. https://www.encyclopedia.com/politics/encyclopedias-almanacs-transcripts-and-maps/congressional-standing. The key to standing is proving “injury,” but who actually would be injured if the government issues debt in order to avoid injury to the entire economy? Moreover, the Court in the past has taken a dim view of getting involved in “political questions” which involve disputes between the other two branches of the government.
If someone or some groups did challenge the new debt issues in court, any unfavorable lower court ruling no doubt would be stayed pending Supreme Court review. While the Court would be deciding on such appeal, debt would continue to be issued, and the clock would be ticking toward or past the September 30th appropriations deadline. That deadline is real and would force the Administration to deal with the House, but then on terms the Administration wants, outside the debt ceiling context. If no deal were reached while the Supreme Court is considering the constitutionality of the debt issuance in the meantime, then at worst the impact on the economy would be limited to about 5% of GDP. But even the prospect of that hit should be enough to induce the Court to find a way to avoid voiding the bonds that had been issued in the meantime, and causing a potential financial panic.
One alternative to issuing conventional debt to keep the rest of the government running is issuing “consols” that have no face value but promise interest in perpetuity. This trick would technically get around the debt ceiling which only applies to debt having face value. (Josh Marshall has published this idea in Talking Points Memo of May 3, but I haven’t linked to it because my computer says the link is “not secure). This maneuver might not stop someone from suing, but this trick may have stronger legal legs.
Of course, any conventional (or unconventional) bonds issued before a deal is struck on a debt ceiling would carry some risk premium, but that wouldn’t stop the bonds from being issued. The real risk of issuing the bonds is political. The President would be accused by Republicans of being both lawless and crying wolf about the debt ceiling all along (I know the two claims are inconsistent, but when does consistency matter in Washington?). The flip side, politically, of continuing to issue debt is that it would eliminate the leverage the debt ceiling thus far has given Republicans (or future Democrats with a Republican president). Of course, you can also count on Republicans blaming Biden if he didn’t issue bonds (or undertake any of the measures short of that, also outlined above) to avoid an economic calamity. Given that he will be attacked either way, the President simply ought to do what’s best for the country, the politics be damned: continue issuing debt, paying bills Congress already has authorized must be paid., and keeping the government open.
Still, the Administration will need to deal with House budget demands as the September 30th appropriations deadline approaches. If no budget deal is struck, then the government shuts down – again – which means “essential government workers” (the military, federal law enforcement personnel and other workers designated under by now well-tested protocols) continue to work, but without pay. If I am right about how the government would handle the debt ceiling crisis before then, payments due under entitlement programs (Social Security/Medicare) and interest on the debt would still be made. The political game of chicken now being played out over the debt ceiling would simply move on to an appropriations/shutdown fight. For background, the last shutdown, while President Trump was president, occurred during the winter of 2018-19 and lasted 35 days, until Trump relented on tying expenditures to his border wall. How long any future shutdown might go on is anyone’s guess.
It may come down to what the House Republicans who are on the “problem solvers” caucus with moderate Democrats: (https://problemsolverscaucus.house.gov/members) decide to do. Eventually a few of them might have to cross the aisle to vote with Democrats on a final deal, given that the extreme House Republicans (Greene, Gosar, Goetz, et al) are unlikely to support any “compromise.” Republicans who did that might put their political futures at risk, although coming to the economy’s rescue could help them in their reelection fights in contested districts. Another wild card, again, is Senator Manchin, who is up for reelection in 2024, facing a stiff Republican challenge. Manchin has been insisting that Biden negotiate now, but who knows exactly what kind of deal he calculates to be in his best political interest? At the end of the day, I believe he comes out at or near the compromise I sketched out much earlier.
To sum up, I believe ways will be found around the debt ceiling calamity many fear. The Administration and House eventually will do a deal to cap spending, but only in the context of the appropriations deadline of September 30th. That deal will push any real budgetary decisions until sometime past the 2024 election.
Those who think that “budget” stories are boring are likely to change their minds after witnessing budget and spending events likely to unfold over the next several months. It is a sad commentary on the state of our politics and our country that this seems destined to happen.
Thanks for your insight on this confusing (for me) situation. I always feel my IQ has increased a little every time I read on of your articles.
Perhaps a tax increase is at least part of the solution, but we seem quite committed in the opposite direction.