Tag: debt limit

Federal Budget Cap at 3%

The federal government is approaching its legal borrowing limit, and fiscal conservatives in Congress are wondering what spending reforms they can extract in return for supporting a debt-limit increase. Various sorts of balanced budget amendments and debt limits relative to GDP are being kicked around. I support those ideas, but I fear that they may be too complicated to gain traction right now.

A simpler idea would be to impose a statutory limit on annual spending growth of 3 percent. If total federal outlays in a year were $4 trillion, the government couldn’t spend more than $4.12 trillion the next year. It would be that simple.

Such a limit would be easy for policymakers and the public to understand and enforce. It would put ongoing pressure on Congress to cut discretionary programs and reform entitlements. With spending growth limited to 3 percent, the budget would be balanced in just over a decade and growing surpluses would be generated after that. The federal government would shrink as a share of GDP. The math is simple: federal revenues and GDP are expected to grow substantially faster than the 3 percent spending limit over the next decade and beyond.

I want Congress to enact major cuts to spending, not just to limit spending growth. But one advantage of an annual growth cap is that it would lock-in any spending cuts that are made, and thus spending would be ratcheted downwards.

Under such a limit, the OMB and CBO would issue regular reports showing spending for the coming fiscal year relative to the projected legal cap, which would make it clear to political leaders, reporters, and voters how much needs to be cut. The president would also be required to propose a budget each year that fit under the estimated legal cap. If the beginning of a new fiscal year arrives and spending is still expected to be above the limit, the president would be required by law to impose an across-the-board cut to bring spending into line.

In the past, I’ve proposed a spending growth cap equal to the sum of inflation plus population growth. (This sum is expected to be about 3 percent in coming years). But a fixed and explicit percent cap would be even simpler and easier to enforce. A fixed percent cap would also encourage policymakers to support a low-inflation policy by the Fed because the lower was inflation, the higher the budget limit in constant dollar terms.

The chart shows the proposed spending in Obama’s new budget compared to spending capped at 3 percent. The spending cap line assumes that the GOP’s discretionary cuts are put in place this year. It also assumes that spending grows at the maximum 3 percent each year, but if spending were restrained more than that, the cap would ratchet down to a lower level. The chart also shows projected federal revenues based on CBO data, assuming the extension of current income tax cuts and AMT relief. (See page 22).

Limiting spending growth to 3 percent is a modest goal, but over time the results would be quite dramatic compared to Obama’s no-reform spending plan. Spending in 2021 would be about $1 trillion less than the president is projecting—$4.7 trillion rather than $5.7 trillion. As a share of GDP, Obama’s 2021 spending of 23.9 percent would be cut to 19.9 percent. And the budget would be closing in on balance that year with revenues at 18.6 percent of GDP with tax relief in place. (Figures based on OMB GDP).

At DownsizingGovernment.org, I’ve proposed spending cuts that would take the federal government down to 15 percent of GDP or less. But getting a new budget mechanism signed into law takes centrist support, and I think that a 3 percent growth cap to balance the budget in a decade or so is a reasonable goal that could gain broad agreement.

Finally, it makes sense to include in such a budget law the ability of policymakers to spend over the cap temporarily for emergency war funding with a two-thirds vote in both House and Senate. Without such a temporary escape hatch, Congress would likely simply repeal the law when it entered a costly war.

I’ve discussed a spending growth cap in more detail here and here and here. Dan Mitchell has made similar observations about spending growth rates. The folks at One Cent Solution are recommending a tighter cap.

Senator Toomey’s Legislation Would Protect Financial Markets During a Debt Limit Showdown

There will be several pivotal fiscal policy battles this year and the fight over the debt limit may be the most crucial.

This is a “must-pass” piece of legislation, so it will be a rare opportunity for fiscal conservatives in the House to impose some much-needed spending restraint.

But it’s also a high-stakes game. If Obama (or Reid) refuses to accept the fiscal reforms approved by the House and there is a stalemate, the federal government ultimately would lose its ability to borrow from private credit markets. And while that notion has some appeal for many of us, it almost certainly would require more fiscal discipline than the political system is willing to accept (i.e., actual deep cuts rather than just restraining the growth of spending).

In a bit of reckless demagoguery, the Treasury secretary even says it would mean default – which could cause instability in financial markets.

To preclude that possibility, Senator Toomey of Pennsylvania has a proposal to protect the “full faith and credit” of the United States by requiring the federal government to make interest payments a top priority. Writing for Bloomberg, I opine about the Senator’s proposal.

…the federal government is expected to collect more than $2.1 trillion of tax revenue this year, while interest payments on the publicly held debt will only be about $200 billion. So even without an increase in the debt limit, the Treasury Department will have more than enough revenue to cover its interest obligations and avoid a default. That being said, financial markets are sometimes spooked by uncertainty. And since Treasury Secretary Timothy Geithner began making some irresponsible statements about the risks of default, there is growing interest in legislation by Senator Pat Toomey, a Republican of Pennsylvania, to alleviate the market’s fears. Quite simply, Toomey’s bill would require the federal government to fulfill obligations to bondholders before making any other disbursements. …If the Toomey legislation is adopted, fiscal reformers will have a powerful weapon at their disposal. Secure in the knowledge that default no longer is a possibility, they can be much tougher in their negotiations with the politicians who favor the status quo. This explains the attacks against the Toomey plan. Some even argue that the law requires the government to pay Chinese bondholders (gasp!) before it pays Social Security recipients. This is demagoguery. The federal government will collect more than enough revenue to finance the majority of budgeted outlays. Social Security checks will be disbursed, unless the Treasury secretary decides otherwise. In any event, the attack is rather hollow since it’s almost always made by people who say that default would be a cataclysmic event. What they really mean, it seems, is that deficits, debt and default are bad, and only higher taxes are the solution. That’s what this debate is all about. We have a fiscal crisis caused by too much spending, not too little taxes. Restraining the size and scope of government is contrary to the interests of the iron quadrangle of politicians, interest groups, lobbyists and bureaucrats who benefit from ever- expanding government.

Swap Debt Limit for ‘Cut and Cap’

Gross federal debt just hit $14 trillion and will soon reach the legal limit of $14.3 trillion. House Republicans are wondering what spending reforms they can extract from the Democrats for their support of a debt-limit increase.

I propose a “Cut and Cap” strategy. The GOP should insist on the $100 billion in initial cuts they promised, and also demand passage of a legal cap on overall federal spending. A simple form of such a cap would specify that total federal outlays cannot rise more than inflation plus population growth each year. If it did, the law would require that the president sequester, or cut, spending across-the board to meet the limit.

The chart illustrates the power of such a cap. The top line shows total spending as projected under President Obama’s budget. The president has spending growing at an average annual rate of 5.6 percent between 2013 and 2020, which is absurdly high given that we are running trillion-dollar deficits. The bottom line shows spending capped at 3 percent annual growth, which is roughly the sum of expected population growth and inflation.

Even with the modest goal of limiting spending growth to 3 percent, the results would be dramatic over time. Spending in 2020 would be $1 trillion less than the president is projecting—$4.6 trillion rather than $5.6 trillion. As a share of GDP, spending would be 19.2 percent instead of Obama’s projected 23.5 percent. That would put the budget close to balance as revenues will be about 18.5 percent of GDP in 2020 with current tax cuts in place.

The chart assumes that the cap and the $100 billion of cuts are put in place right away. However, because Obama’s budget assumes that spending is flat for the next two years as “stimulus” spending peters out, the cap wouldn’t really start biting until 2014.

I’ve discussed a spending growth cap in more detail here and here. One nice feature of such a cap is that any spending cuts achieved would be locked-in as the spending limit would ratchet downward to the new lower budget level. So the House Republicans should insist on “Cut and Cap” this year, and then keep on cutting after that.

Thoughts on the Debt Limit Debate

The origins of the federal government’s statutory debt limit can be traced back to 1917, when the country was borrowing money to finance the Great War. Congress has voted to increase the limit numerous times over the decades, including 10 times since 2001.

The present debt limit is $14.3 trillion, and total outstanding debt subject to the limit currently stands at just under $14 trillion. Given that policymakers don’t have the will to cut spending immediately in order to keep the debt from hitting the limit, a political battle over raising it is unfolding.

The Obama administration is basically warning that congressional (i.e., Republican) intransigence over raising the limit could potentially lead to the federal government defaulting on its debt, because it needs to borrow money in order to make its debt payments. Treasury Secretary Tim Geithner warned Congress that failing to increase the limit would result in “catastrophic economic consequences that would last for decades.” The president’s chief economic adviser, Austan Goolsbee, warned Congress not to “play chicken” over whether to raise the debt limit, as failing to do so would cause “a worse financial economic crisis than anything we saw in 2008… This is not a game. The debt ceiling is not something to toy with.”

Back in 2006, then-Senator Barack Obama apparently wasn’t concerned about the “catastrophic economic consequences” when he voted against raising the debt limit. ABC News recalls Obama’s stated reason for his “no” vote:

The fact that we are here today to debate raising America’s debt limit is a sign of leadership failure,” he said on March 16, 2006. “Leadership means that ‘the buck stops here.’ Instead, Washington is shifting the burden of bad choices today onto the backs of our children and grandchildren. America has a debt problem and a failure of leadership. Americans deserve better. I therefore intend to oppose the effort to increase America’s debt limit.

That’s actually well stated, although we now know that Obama’s own failure of leadership is also “shifting the burden of bad choices today onto the backs of our children and grandchildren.”

The president’s press secretary says that Obama voted against raising the debt limit because the outcome wasn’t in doubt and “to make a point about needing to get serious about fiscal discipline.” While the revelation is as unsurprising as it is cynical, it demonstrates that the debate over raising the debt limit is mainly driven by politics.

I strongly doubt that the Republicans will ultimately take actions that lead to the federal government defaulting on the debt. They’re simply using the debt limit issue to make political hay over the administration’s fiscal failures, just as Obama did when he was in the Senate and fiscal policy was being made by Republicans.

The never-ending political posturing by both parties when it comes to raising the debt limit has caused some commentators and budget analysts to suggest that Congress should just do away with the limit altogether. They argue that the political brinkmanship simply isn’t worth the risk to the country’s economic well-being.

I believe that forcing policymakers to spar publicly over fiscal policy is healthy, especially at a time when analysts generally agree that the country is headed toward an economic catastrophe if Washington’s mounting debt isn’t brought under control. The country’s economic well-being is already at risk, so I don’t see what there is to be gained from scrapping a tool, albeit a politicized one, that focuses needed attention on a serious problem.

A 2005 paper by Prof. Anita Krishnakumar is similarly supportive:

First, the statute is the last remnant of congressional control or accountability over the national debt—and the primary vehicle through which Congress fulfills its constitutional obligations under Article 1, Section 8 to oversee the borrowing and payment of the public debt. Second, the debt limit statute encourages legislators to consider the interests of the general public and future generations, rather than those of special interests, and thus acts as an important institutional check on party and interest group politics.

As this Article details, the general budget process is party- and interest-group dominated, and involves numerous competing concerns and aggregate figures, among which the annual deficit (borrowing) figure and the status of national debt are only one [sic] of many concerns. Within this framework, debt limit increase bills provide an independent and focused opportunity for Congress to step back and consider the consequences of its deficit-spending decisions, to evaluate its fiscal policies, and even to implement fiscal reform if it decides  that it has been borrowing too much too fast.

Krishnakumar concludes that although the debt limit requirement is “far from perfect,” the “criticisms leveled against the statute … are both exaggerated and misdirected.”

In sum, the federal government is not going to default on its debt obligations in the coming months because of a failure to raise the debt limit. The real intrigue is the political gamesmanship that a vote to raise the debt limit will engender. In this regard, Republicans should use the vote as an opportunity to press the administration for budgetary reforms that address a potentially ruinous debt burden that has been driven by the profligate spending policies of both parties.

Put Housing GSEs in the Budget and then Privatize

The two large housing government-sponsored enterprises, Fannie Mae and Freddie Mac, have been in government receivership since September 2008. The U.S. Treasury has given the housing GSEs $112 billion in cash infusions, and this past Christmas Eve it quietly announced it would cover all of Fannie and Freddie’s losses beyond the original $400 billion limit through 2012.

The president’s latest budget proposal continues to only count the cash infusions, which it projects to be $188 billion through 2020. On the other hand, the Congressional Budget Office also includes in its budget projections the subsidy cost of new loans or loan guarantees made by Fannie and Freddie, which results in a total projected hit of $370 billion through 2020.

The CBO’s rationale for including the subsidy cost is obvious:

[T]he Congressional Budget Office (CBO) concluded that the institutions had effectively become government entities whose operations should be included in the federal budget.

Is it not obvious to the administration?  Of course it is, but the administration doesn’t want the GSEs “on budget” because it will only make already dismal deficits look worse. It also hinders any effort to count the GSE’s combined $1.5 trillion in outstanding debt against the ever-increasing federal debt limit. Yesterday, Treasury Secretary Geithner waived the idea away when he told the Senate Budget Committee that “we do not believe it’s necessary to consolidate the full obligations of those entities onto the balance sheet of the federal government at this stage.”

Geithner also told Congress the administration will now wait till 2011 to propose an overhaul of Fannie and Freddie. The Associated Press noted the hypocrisy in the administration’s punt:

‘We want to make sure that we are proposing these changes at a time when we have a little bit more distance from the worst housing crisis in generations,’ Geithner said. That argument is exactly the opposite of the case Geithner is making for new financial regulations. Geithner is pressing Congress to move swiftly on new Wall Street rules, saying action must occur before memories of the financial crisis recede.

Geithner said he wanted measures that would ensure “the government is playing a less risky, but more constructive, role in supporting housing markets in the future.” But government “support” of the housing market is what fueled the housing bubble and subsequent damage to the economy. Why should the arsonist be trusted to put out the fire?

Unfortunately, policymakers get a lot of self-serving prompting from the housing industry, as I discuss in this Cato Policy Analysis. For example, the National Association of Realtors is currently shopping a plan on Capitol Hill that would turn Fannie and Freddie into government-chartered non-profits explicitly backed by the government. Instead, policymakers should begin the process of separating housing finance and state by developing a plan to privatize Fannie and Freddie.