Debt Limit Strategy

The United States debt limit has to be raised. There is no question about that. The way appropriations in the US work is that Congress first passes a budget, and then if  the budget is not balanced, they approve an increase in the US’s debt ceiling (they authorize the treasury to lend money) to cover  the debt they just signed into law in their budget. This makes many budgets a 2-step process. Earlier this year, Congress (Republicans and Democrats) signed a budget that busts the debt limit and no one has produced an alternate that will keep us from hitting the debt ceiling on Aug 2. That means that all these negotiations leading up to a signing of the debt limit increase are just a prelude to the inevitable. So what’s all the fuss about?

(Its a long post, so skip this section and the next if you’re up-to-date on the debt limit negotiations)

Republicans are currently threatening not to increase the debt limit and thereby render all the new debt they voted into law null and void. If Aug 2 comes along and the debt limit is not raised, the Treasury will not be able to issue any more debt and so will have to stop paying for things. This would amount to a partial default by the United States and would mean that the US would have to immediately stop paying for some of the major things it does. Specifically,  it would have to completely cut 2 of its 5 major spending areas (or significant portions of all 5):

  1. The Defense Department
  2. Social Security
  3. Medicare
  4. Medicaid
  5. All other domestic spending (Education, EPA, National Parks, Homeland Security, etc )

Needless to say, stopping all payment for anyone of these programs would withdraw billions from the economy. Soldiers, doctors and government employees could go without pay or the elderly could stop getting their social security checks from the government. This would plunge the US back into a recession. That’s not to mention the harm this would do to our ability to lend and borrow money in the future. I wrote a  post  talking about how we are essentially borrowing money for free right now (its a bit of an over-simplification, but bear with me). As you probably have heard, US government debt is backed by “the full faith and credit of the United  States.” Not raising the debt limit would violate  the full faith and credit of the US for the first time in history and would convince many creditors that they should not lend to us (or at least not lend to us at such good rates) in the future. And just like that, our days of cheap borrowing are gone and the debt skyrockets because suddenly we have HUGE interest payments on all of our once cheap, cheap debt.

Now for the interesting stuff…

The Republican leadership knows very well the calamity that would ensue if the debt limit is not increased, however,  they see this as an opportunity to force Obama and the Democrats in the Senate to agree to drastically cut government spending.  If the economy gets wrecked because  the government defaults on its debt, it is very unlikely that Pres. Obama will be re-elected. Republicans are betting that if that happens, the American people will blame the man at the top (Obama)  instead of them for causing the nation’s economy to implode. Even if both Congressional Republicans and Pres. Obama get blamed, that’s still good for the Republican Party because they get to install a Republican president in 2013. So, Republicans are betting that Democrats will stop at almost nothing to get a deal worked out on the debt limit. And, since Republican votes are needed for any debt limit increase (the Republicans control the House of Representatives), that deal will have to be worked out on the Republicans’ terms.

Republicans’ demands are for $2 trillion in spending cuts over the next 10 years. Note: they are not asking for $2 trillion in debt-reduction over the next 10 years, they want $2 trillion in spending cuts.  Well, that’s kind of the same thing, right? No. Lots of time spending cuts can increase the deficit. For instance, cutting money from the IRS leads to more people cheating on their taxes, which increases the debt while lowering spending on preventive medical care can increase costs on acute care down the road. Focusing on spending cuts as opposed to debt reduction also leaves increasing taxes out of the equation and in a world where debt=revenue-spending, leaving out one side of  the equation  is a pretty big omission. Predictably, that’s where the sticking point is now.

Democrats have insisted, quite wisely I think, that this be a debt-reduction package and that it also be a compromise between the two parties. Democrats have argued that since the Republicans insist on cutting programs that benefit the poor and middle class (like Medicare and Medicaid) some tax breaks should be ended for the very rich, so that the pain from this deal is spread to everyone. You would expect a deficit-reduction “grand bargain” to be 50% tax increases (which are favored by Democrats) and 50% spending cuts (which are favored by Republicans).  Here, Democrats have come all the way down to asking that 17% of the package be revenue increases (showing their weak bargaining position).  Ezra Klein explains what specifically the Democrats have asked for: (more info here)

Specifically, the Obama administration was looking at a rule that lets businesses value their inventory at less than they bought it for in order to lower their tax burden, a loophole that lets hedge-fund managers count their income as capital gains and pay a 15 percent marginal tax rate, the tax treatment of private jets, oil and gas subsidies, and a limit on itemized deductions for the wealthy.

So, the Democrats want a compromise where the ultra-rich (hedge-fund managers, owners of private jets and oil companies)  pay 1 dollar more in taxes for every 5 dollars cut from programs that benefit the poor and the middle class. Republicans have rejected ANY plan that attempts to draw ANY extra revenue from ANY source. Note that the “tax increases” outlined above  aren’t even really tax increases at all because they don’t actually raise anyone’s tax rates. All they do is close a few different loopholes that the rich and some corporations use to get out of paying taxes. But that doesn’t matter to Republicans because ANY additional revenue for the federal government is unacceptable.

See, the debate here is not “let’s Democrats and Republicans come together to hash out a deal to reduce our debt and then raise the debt ceiling,” it is Republicans saying: “give us what we want and we will help you to raise the debt ceiling and keep the economy from imploding.” Republicans are saying that if they don’t get  their way, they will destroy the US economy. In this they are making a bet that the Democrats care more about the economy than they do, and so will be willing to agree to whatever demands  they make in order to keep the economy afloat.

The Republican Political Calculus

In an earlier post, I argued that the government should increase the money it is putting into the economy in order to help us get out of this low-growth funk. This is the view advocated by many economists and many liberals in Congress. Well, if the government putting money into the economy would help us out short term, then obviously taking money out of the economy will hurt the economy in the short term. This is part of the Republican calculus.

At the very least, Republicans expect to get a deal out of the President that will slowly sap our economic strength by removing hundreds of billions of government dollars from the economy over the next few years. Republicans are hoping that this will hurt the economy enough to deny Pres. Obama re-election next year. It is widely acknowledged that unless the economy improves, the voters will punish Obama in November 2012, so the Republicans do want a weak economy between now and then.

Republicans also hope that cutting this deal with them will alienate Obama from his liberal political base. Republicans only need Obama and a handful of moderate Democratic Senators to pass their spending cuts and increase the debt limit. If they can get Obama to agree to a plan full of painful cuts to Medicaid and Medicare and nothing in return (except their agreement not to destroy the economy), liberals will be infuriated. Especially if the plan passes with only token Democratic support in Congress, Obama will risk disenchanting his strongest supporters in advance of the coming election.

Republicans are also being so demanding because  they know that if Obama wins re-election, then come January 2013, the Bush tax cuts are up again for renewal. Obama has promised to veto any attempt at renewing Bush’s tax cuts for the richest 2% of the population. Republicans want the tax breaks for the rich to be renewed more than almost anything. At that point the dynamic will be reversed. Republicans will have to play on Obama’s terms and will have to decide whether they want to agree to Obama’s demands and let the tax cuts for the rich expire, or whether they want to let taxes rise on the other 98% of people in America in a PR nightmare. Of course, if  Obama doesn’t get re-elected they don’t have to worry about that. If  he still does get re-elected and the tax cuts for the rich expire, well then Republicans will say that it was a good thing they held the line against higher taxes on the rich when they had  the upper-hand in the debt ceiling negotiations. Because the worst thing in the world would be for the rich to have their taxes raised twice.

In conclusion, there is a good chance the debt limit is unconstitutional.

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