A Debt Ceiling Lesson from Europe

After decades of over spending, European nations are now being forced to adopt serious debt control measures.

American progressives are fond of gazing across the pond at Europe and wishing the U.S. would emulate it. So as soon as President Obama started announcing from all reaches of the country that Congress "must" eliminate the debt ceiling, progressive cheerleaders echoed his demands, pointing out that most European countries did not have a debt ceiling.

But Europe worshippers are drawing the wrong lesson from across the Atlantic. Despite public protests against austerity cuts, many European countries are instituting constitutional reforms requiring balanced budgets in the form of "debt brakes"—a far stronger way to control the national debt than a debt ceiling.

Conservatives typically argue that the debt ceiling offers a check on Congressional spending by limiting how much the country can borrow when tax receipts run out. Progressives, however, counter that the debt ceiling irresponsibly raises the specter of a credit default, hurting lender confidence in America.

Reuters blogger Felix Salmon has even argued that the debt ceiling is a "political distraction at best" that might trigger an economic crisis at worst. It's hard to argue with that given that Republicans ignore the debt ceiling when they have power but defend it when they do not.

The ceiling has been raised 68 times since 1960-including 18 times under Ronald Reagan, and by nearly $5 trillion under Barack Obama. Not surprisingly, government spending has gone through the roof along with the size of the public debt.

What's the point of having a debt ceiling if every time we approach it Congress just finds a way to circumvent it?

The debt ceiling didn't start as a political distraction. Under the Constitution, any government spending or borrowing has to be authorized by Congress. For the first 150 years of America's existence, that is, most of the republic's life, Congress authorized debt for specific purposes such as funding wars or building the Panama Canal.

In 1939, however, in order to give President Roosevelt flexibility to conduct World War II, Congress gave up its power to approve specific debt issuance but set a maximum aggregate borrowing limit for Treasury. Voila, the debt ceiling was born.

However, what began as wartime "necessity" evolved into peacetime political cover that no longer required Congress to justify increasing specific borrowing. It simply authorized spending and let the Treasury Department sort out the necessary borrowing.

The results of this bargain speak for themselves. Since 1940 Congress has run a deficit nearly every year (62 of 72 years). The federal budget has grown from roughly 15 percent of GDP in 1950 to about 25 percent today. And America has now borrowed over $16.4 trillion-roughly equal to the size of the entire U.S. economy!

America has not been alone in racking up such a large credit card bill. Greece—the land with debt-to-GDP above 150 percent—leads the way among her Eurozone peers. And countries like Italy (127 percent), Portugal (120 percent), Ireland (117 percent), and Spain (77 percent), followed a similar pattern of unfettered debt accumulation. Even the uber-responsible Germans let their debt rise to 80 percent of GDP. These debts have crippled the European economy in recent years. And since they don't have the luxury of irresponsibility that America's reserve currency gives us, Europe's leaders have started taking debt seriously.

One method for debt control that has gained popular support is the Swiss "debt brake." Adopted into Switzerland's constitution in 2001, the debt brake requires a balanced budget, but measured over a multiyear period. In technical terms, it requires the nation's "structural deficit" to be nil over the course of a business cycle so that surpluses generated during boom periods can defray the deficits during bust periods to keep the overall debt manageable.

Implicit in the debt brake idea is the recognition that constraining debt is important to honorably meet national debt obligations and avoid default—whose very prospect American liberals raise to justify their calls for scrapping the debt ceiling.

Germany, for example, has now adopted the Schuldenbremse (debt brake) concept as well, specifying that its structural deficit cannot exceed 0.35 percent of GDP in any given year. This does not cap aggregate debt, but the idea is that if the federal government is not running huge deficits every year, the national debt won't grow.
Of course, the debt-brake idea is not perfect, but it is far more effective than America's weak-kneed approach to curbing deficits.

Switzerland's public debt has dropped from 55 percent of GDP to 40 percent from 2003 to 2010. More recently, Germany has quickly met its Schuldenbremse target of balancing its budget, two years ahead of schedule. In contrast, America has been running a structural deficit of roughly 6 percent of GDP annually since 2009.

A Schuldenbremse-styled constitutional cap on the federal deficit in the U.S. would both constrain spending-by forcing Congress to make necessary cuts to the budget to meet the debt brake, including entitlement liabilities-while at the same time slowly bring down the aggregate public debt outstanding over time.

Congress could choose to raise taxes instead of cutting spending. But the reality is that Congress already taxes American citizens when it overspends revenues, forcing Treasury to issue more debt. Since this debt will have to be paid off eventually with taxpayer money, running a debt-financed deficit is in effect raising taxes on future generations. The debt brake would just force Washington to be more honest with voters if Congress decided to try and sell a tax hike to the America people.

In an ideal world, Congress should adopt a constitutional limit on the size of the federal budget itself, instead of just focusing on debt and deficits. The average federal budget over the past 60 years has been 17.8 percent of GDP, meaning at the very least we could pare the budget down to around that level without the horrific Social Darwinism so feared by progressives. In lieu of this reform, a constitutional debt brake is the next best option that has shown some real world results.

The real take away from Europe is that weak debt control mechanisms ought to be strengthened—not weak ones such as the debt ceiling eliminated, especially if we want to avoid Europe's current miserable economic fate.

This article originally appeared at RealClearMarkets.