“The debt ceiling is an important tool for addressing debt and deficit,” suggests Rep. Adrian Smith (R‑NE).
“Failing to raise the limit would lead to a catastrophic default that would rattle global financial markets and could risk throwing the U.S. into a recession, economists say” report the Washington Post’s Jeff Stein and Marianna Sotomayor.
Which is it? Is the debt limit a critical fiscal tool to rein in debt? Or is it an irresponsible bargaining chip that threatens to cause economic havoc?
It’s both. This is where a two-handed economist comes in handy.
On the one hand, reaching the debt limit provides an important wake-up call to legislators to reform spending practices. Reforms should prevent the government from taking on even more debt in the future. As Figure 1 below illustrates, the debt subject to the limit is growing at an accelerating pace. Leveraging the debt limit to reform spending practices is particularly relevant because two-thirds of the federal budget grows on autopilot. Instead of lawmakers authorizing spending annually, spending grows based on statutes that, in some cases, were adopted decades ago.
Think Medicare and Social Security. Spending on these programs is growing as the U.S. population is aging and living longer. This means there are more benefit recipients, compared to the workers paying for those benefits. And entitled beneficiaries are receiving greater benefits over their extended lifetimes. The debt limit provides a potential trigger to reform programs that are growing on autopilot before lawmakers are forced to make changes during a potential fiscal crisis. Or when the trust funds governing Medicare and Social Security become depleted and more gradual policy reform options are off-the-table.
On the other hand, raising the debt limit does not enable new spending. The debt limit law authorizes Treasury to create new debt when tax revenues are insufficient to cover existing obligations. Which is pretty much all the time given that the government is running continuous deficits. The last time the federal budget recorded a surplus was in 2001.
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