Editor’s Note: Reason columnist Veronique de Rugy appears weekly on Bloomberg TV to separate economic fact from economic myth.
The statutory debt limit, or debt ceiling, was designed to control congressional spending by limiting the amount of debt the federal government could accumulate. Clearly, it has not fulfilled its legislative purpose. In fact, the government has lost its ability to monitor its own spending. Having to raise the debt ceiling yet again is a sign that Congress has failed to do what is necessary to get the nation’s finances in order. Here are three myths about the debt ceiling, each one rebutted by a fact.
Myth 1: Failure to increase the debt ceiling is insanity. Unless we increase the debt ceiling, the U.S. government will default on its debt.
Fact 1: The federal government has other options. If the debt ceiling is not increased, the Treasury Department can make interest and debt payment its first priority to avoid a default. Then it can essentially put the government on a stringent pay-as-you-go basis.
The Obama administration warns of an economic armageddon if Congress doesn’t raise the debt ceiling. It is called “insanity” not to take the simple step of allowing the government to borrow more money. Treasury Secretary Timothy Geithner has warned that if we don’t increase the debt ceiling the U.S. would default, resulting in a bond market crash with disastrous impacts felt at home and abroad.
Technically, if the debt nears its statutory limit, the Treasury Department cannot issue new debt to manage short-term cash flows or manage the annual deficit—the government may therefore be unable to pay its bills. But in the real world things are different.
First, if the debt ceiling is not increased it doesn’t mean the federal government will have to repay the entire debt at once. The government just won’t be able to increase its borrowing. Americans understand the difference between not being able to borrow more money and defaulting on one’s mortgage.
Also, while Congress has never before refused to raise the debt ceiling, it has frequently taken its time about doing so (see the chart below). In 1985, for example, Congress waited nearly three months after the debt limit was reached before it authorized a permanent increase. In 1995, four and a half months passed between the time that the government hit its statutory limit and the time Congress acted. And in 2002, Congress delayed raising the debt ceiling for three months. It took three months to raise the debt limit back in 1985 as well. In none of those cases did the world end.
More importantly, the Treasury Department has other options. For instance, if the debt ceiling is not increased, the Treasury can prioritize interest and debt payment to avoid a default. The chart below shows what part of the budget Treasury needs to cover with tax revenue to avoid a default.
If Congress refuses to raise the debt ceiling, the federal government will still have more than enough money to fully service the debt. This year, for instance, about 6.1 percent of all projected federal expenditures will go to interest on the debt, and tax revenue is projected to cover about 60.1 percent of all government expenditures. With roughly 10 times more income than needed to honor its debt obligations, why would the government ever default?
Let’s sum it up: As long as the government continues to pay interest on the debt, then it technically is not in default. With tax revenues expected to be $2.2 trillion, interest payments amount to roughly $300 billion—this would still leave $1.9 trillion in revenues to pay for the government's most important priorities. For instance, lawmakers could decide to honor the promises made to people benefiting from entitlement spending, such as Social Security, Medicare, and Medicaid. In that case, even after paying for all of the entitlement spending, the Treasury would still have $300 billion left.