If neither side budges, and the debt ceiling remains fixed, some people worry this might lead to a default by the U.S. government. More specifically, they’re concerned that the inability to issue debt would compromise the Treasury Department’s ability to make scheduled payments to bondholders. They also worry this might lead to a Greek‐style sovereign‐debt crisis that would destabilize financial markets.
This seems like an overblown fear. After all, 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.
Spooked by Uncertainty
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.
To the extent that investors actually are worried, Toomey’s legislation would remove ambiguity and, to borrow from the title of the bill, make clear that the “full faith and credit” of the U.S. government would be preserved.
Toomey’s proposal has generated a lot of angst among Beltway insiders because it would change the political dynamics of the budget fight. Politicians love to pontificate about the dangers of debt, but many of them are MIA when it comes to putting real limits on the growth of government spending.
It’s much easier to put the budget on auto‐pilot and delay tough choices, which is usually what happens with closed‐door budget compromises in Washington.
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.
That’s exactly why the Toomey bill is a good idea. It would give budget cutters the leverage they need to change the way the government operates. It will protect America from becoming a slow‐growth, European‐style welfare state.