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Debt Limit and Long-Term Deficits Are Separate Issues

Policymakers are playing with fire as they risk a default on U.S. federal obligations because of a dispute over how to reduce budget deficits.  The nation’s long-term fiscal path is unsustainable, and policymakers should address it in a timely and responsible way.  But as we explain in a new report, legislators should not hold the debt limit hostage to approval of deficit reduction measures that satisfy various ideological or political concerns.  Policymakers cannot let the government default.

The President and Congress set budget policy through spending and tax legislation that is separate from the debt limit.  Policymakers should raise the debt limit promptly to avert a default while they continue to work on a long-term deficit reduction package.  In fact, as part of a long-term package, they should consider eliminating the debt limit altogether.

As the Financial Times recently editorialized, “Sane governments do not cast doubt on the pledge to honour their debts — which is why, if reason prevailed, the debt ceiling would simply be scrapped.”  We agree; so do Economist Glenn Hubbard (chairman of the Council of Economic Advisers under President George W. Bush), superstar investor Warren Buffett, budget expert Donald Marron, the credit rating agency Moody’s, and many others.  As the events of recent weeks make clear, the debt limit creates opportunities for political mischief while putting the nation’s financial standing at risk.

Congress’ failure to raise the debt limit in a timely manner would leave the Treasury powerless to borrow money except to refinance maturing securities.  With the power to spend only what it collects in revenues, the government would have to cut spending abruptly  — by 44 percent in August, according to the Bipartisan Policy Center —  putting an enormous drag on economic growth at a time when the economy is struggling to recover from the Great Recession.  It also would harm millions of businesses and institutions, employees, state and local governments, and beneficiaries who rely on timely federal contract, reimbursement, benefit, or other payments to meet their own bills and payrolls.

Moreover, while some lawmakers say the Treasury Department could prioritize expenditures to avoid problems after a default, Treasury Secretary Geithner says the Treasury lacks the authority to do so  — and that such a step would not reassure financial markets anyway. History shows that even the uncertainty surrounding a debt limit increase can raise interest rates; rates rose modestly during debt-limit debates in 2002, 2003, and 2010 and during a brief “technical default” in 1979 that was due to computer glitches.  Even a temporary default would throw away the nation’s stellar credit rating and probably raise the government’s borrowing costs permanently.

Federal debt is indeed on an unsustainable path in the long run, and policymakers need to squarely address this challenge.  But the nation does not face an immediate debt crisis, and the long-run fiscal challenge has nothing to do with the debt limit.