Raise the debt limit and cut spending

Raise the debt limit and cut spending

I’d like to explain why I think “payment prioritization” proposals are bad ideas, why and how Congressional Republicans should support a debt limit increase, and why they need to be smart about how they push for spending cuts.

Payment prioritization proposals

As background, in my last post I explained the difference between default and technical default:

Missing or delaying a debt payment on Treasury debt is called default. Missing or delaying other government payments is sometimes called technical default or defaulting on our obligations. While default sounds like technical default, they’re quite different. The first directly threatens the full faith and credit of the U.S. government as a borrower and is a direct attack on our government’s credit rating and borrowing costs. The second is terribly irresponsible, and the government would be sued by whoever’s payments were delayed, but it’s a full step less egregious than defaulting on Treasuries.

I know of two different ideas for “payment prioritization” proposals. One is active, the other passive.

In the active proposal, Congress and the President would enact a law that explicitly prioritizes payments if Congress does not raise the debt limit. These legislative proposals always put debt payments first, an attempt to ensure that if Treasury must prioritize the use of its cash on hand, then there is no risk of the U.S. government defaulting on Treasuries. Instead, the Administration would have to delay paying other obligations of the U.S. government. These bills attempt to leave technical default as a threat while neutralizing the risk of default.

There are at least four problems with this idea.

  1. Credit rating agencies and investors may not be reassured because they may insufficiently distinguish between default and technical default. It’s easy to imagine a credit rating agency downgrading the U.S. for not paying contractors or States on time, even if principal and interest payments on U.S. Treasuries are all being made when they should be. The credit risk might be mitigated but it certainly wouldn’t be eliminated. If you make your credit card payments on time but miss your rent payment three months in a row you’re probably a bad credit risk.
  2. To the extent that the enactment of such a law increased the expectation of future legislative brinksmanship surrounding these non-debt obligations, such a law might actually increase credit risk.
  3. Even if Congress and the President agreed on such a concept in principle, good luck coming up with a short prioritization list to write into the bill. It would start small (debt repayment goes first). Then members would argue whether Social Security recipients, veterans, or active duty troops should be paid next. Maybe cancer research funding comes after those three, or is it money to protect against terrorist attacks? Congress is terrible at setting priorities; that’s a major source of the underlying fiscal problem.
  4. There is zero chance this proposal could be enacted while President Obama is in office. If the goal is to increase leverage of the spending cutters, what makes anyone think it will become law now?

Some conservatives argue for the passive variant of payment prioritization. Let’s vote against raising the debt limit, they argue. Let’s block any bill that increases the debt limit, they say. Treasury will soon run short of cash and have to make choices about where to spend. The pain caused throughout government will hurt liberals more than conservatives because they rely more on government than we do. This will therefore incent Democrats to agree to legislative spending cuts.

I agree that in such a scenario the Administration would place the top priority on repaying Treasury debt so that default is not a real threat. This is the kernel of truth on which the passive variant relies. It’s also why some on the right and the Obama Administration were both horribly wrong and misleading in the 2011 struggle when they argued about the increased risk of default (rather than of technical default) from that summer’s brinksmanship. Treasuries never have been and never will be at risk, because any Administration would use all available legal flexibility to avoid that increased credit risk.

But it’s irresponsible for the government not to fulfill in a timely fashion legal commitments it has already made. This is about the sanctity of contracts and the U.S. government’s credibility as a party to an agreement. If the U.S. government legally commits to paying someone a benefit, or agrees to pay a firm for a good or a service, the U.S. government should fulfill that agreement in a timely fashion. To do otherwise is taking the first step to becoming a banana republic. The fiscally responsible policy is to pay your bills on time and cut future spending commitments.

Also note that payment prioritization doesn’t stop payments, it just delays them. Then the aggrieved party sues the government, and probably wins, and it turns into a bloody mess.

Even if you disagree with me, and you think we need to take extreme measures to force President Obama to agree to spending cuts, and you’re willing to damage the U.S. government’s contracting credibility by starving it of cash by denying it the ability to borrow more, …

… what makes you think the President and his team are going to do so in a way that you like or that creates leverage for Congressional Republicans? Remember, he has the flexibility to decide which payments get delayed.

Today President Obama signaled what he would do in this situation. He will start warning politically powerful constituencies: seniors, veterans, and troops, that they are at risk of not being paid on time, and their Republican Congressman is responsible for it, and his or her phone number is 225-XXXX. I have no idea why some conservatives think it’s smart strategy to hand the President this kind of political club. In the extreme, he could in theory tell his budget director, “Delay payments for highway funds to any State that voted against me in the last election.” That’s absurd and egregious, but my point is that conservatives and Congressional Republicans are foolish in the extreme if they think that a passive payment prioritization strategy would create leverage on the President. It would do just the opposite.

Some then pivot back to the active variant as a solution, “Well, we’ll enact a law saying they can’t stiff troops or veterans or seniors, but the Administration is required to stick it to National Public Radio and welfare.” Okay, but how again do you plan to enact such a law? And we’re back where we started.

Neither active nor passive payment prioritization ideas would work to generate the leverage that spending cutters want. They also happen to be bad fiscal policy (violating contracts and really ugly cash flow management). These are the conservative parallels to the recently deceased trillion-dollar coin idea that was enchanting the left.

There are smarter ways to cut spending, and even to use a debt limit increase to cut spending. Here is one.

To cut spending, raise the debt limit

A better strategy for House Republicans to force some spending cuts on a President who doesn’t want them looks like this.

  1. Rely first on the sequester, second on the CR, and last on the debt limit as leverage.
  2. On the debt limit, state loudly and repeatedly a simple principle: We will pay our bills on time and we will cut future spending.  Rather than being against a debt limit increase unless it also cuts spending, say that you’re for a debt limit increase that also cuts spending. You’re the legislative branch, you control what’s in the law. Act as leaders doing the right thing, rather than as rebels trying to block President Obama and Congressional Democratic spenders from doing the wrong thing. Agree with the President that we must pay our bills, and politely smile and say “And we’re going to cut spending, too.” Make him argue against cutting spending, rather than giving him the opportunity to attack you for risking financial disaster.
  3. Pass a bill out of the House that raises the debt limit and cuts spending.  Make it a short-term extension, maybe 3-6 months, and cut spending by a similarly modest amount.
  4. Take whatever big spending cuts you want and make them conditions of extending the Continuing Resolution. Threaten to shut down the government rather than to make the government risk not paying its bills on time. It’s a less damaging and therefore more credible threat.
  5. Propose specific entitlement spending cuts to substitute for the sequester cuts you don’t like (presumably in defense). On this one sit and wait for Democratic nondefense appropriators to panic. You won’t have to wait long.
  6. Publicly state your willingness to agree to (and vote for) a longer-term debt limit increase as soon as the President is willing to cut spending a lot or at least to commit to a credible long-term fiscal path. If he won’t, state that you will repeat step 3 as often as needed.
  7. If the President threatens to veto your short-term debt limit increase + spending cuts, then tell him you’ll allow House Democrats to pass a clean short-term debt limit extension, but they’ll all have to vote for it, every three months or so. Watch the ensuing panic in the House Democratic caucus with amusement.

There are three key strategic premises upon which this strategy relies:

  • Leverage to cut spending is best implemented through the sequester and CR more than through the debt limit.
  • Leverage on the debt limit can be created only by being for the right kind of debt limit increase (short-term and with spending cuts), and not by threatening to block any increase. The more responsible policy path is also the one that generates more negotiating leverage, albeit in an incremental way.
  • A smart debt limit strategy allows the President an opportunity to get his clean debt limit increase, but only for a short timeframe and only at great political cost to his own party in Congress. This is what creates leverage, not threatening to let the house burn down.

We will soon see whether Congressional Republicans can channel their oft-stated passion and commitment to cutting spending into a strategy that works.

(photo credit: Rod)

 

23 responses

  1. I disagree with two of your points. First, I don’t think the passive prioritization approach is as risky as you are making it seem. When discussing the fiscal cliff legislation, you argued that the Republicans had more leverage than it seemed as President Obama did not want to risk a recession in his final term. I think the President would be absolutely terrified of having his second term devolve into a constant argument as to why he is prioritizing the way he is (not to mention the recession that would likely occur). Second, I really don’t think it would be that big a deal for the Democrats to pass a new ceiling every three months, once people got over the novelty. If anything, it would prove how powerless and inconsequential the Republicans have become under this scenario. I think the Democrats would rub Republican leadership’s nose in it. I hope you follow up on this comment in a future post.

  2. as soon as he prioritized out social security checks republicans would be squealing with their tails between their legs andrew, get real.

    do you think boehner could get 218 votes for a bill that say raised the debt ceiling by $500bn while cutting spending by $800bn assuming dems would 100% oppose? that seems like the obvious way to go as an opening bid. i hope the house members realize they got a much worse deal by voting down boehner’s plan b. if they can pass something like this they’d have real leverage

    • Maybe I am wrong (and in all seriousness would like to be educated if that is the case), but wouldn’t every group that gets prioritized out complain about Obama funding a bunch of other groups that are not as deserving? “Why is Obama funding XYZ while i am not getting my social security” (for what it’s worth, I also can’t imagine Obama zeroing out social security payments. It will be something less urgent than interest payments, social security and military pay checks

      • They won’t even know Obama is picking or choosing. Most of the people in question do not follow this stuff at all. Who do you seriously think they are going to blame? The party that constantly wants to cut spending, and constantly claims default “wouldn’t be a big deal?” Or the party that wants to increase spending (especially on entitlements), and the party that constantly warns about the danger of default? And what happens when this natural inclination (the one thing everyone knows about the parties) is combined with what the Republicans keep claiming is a “biased media?”

        I’m not really worried about the Republicans caving in this scenario. They’ll do so within a week or so, at most. The more interesting question is whether the entire idea of fiscal conservatism is politically damaged in the long term. Many people love to say they want to cut spending in the abstract. But if people start to mentally associate “cutting spending” with “no social security checks,” the political ground could shift more rapidly than people realize.

  3. This strategy is probably the best one available, given the players involved. But its weakness is points 4 and 5:

    “4. Take whatever big spending cuts you want and make them conditions of extending the Continuing Resolution. Threaten to shut down the government rather than to make the government risk not paying its bills on time. It’s a less damaging and therefore more credible threat.

    “5. Propose specific entitlement spending cuts to substitute for the sequester cuts you don’t like (presumably in defense). On this one sit and wait for Democratic nondefense appropriators to panic. You won’t have to wait long.”

    The Republicans won’t have the collective courage to identify “big spending cuts [they] want” and “propose specific entitlement spending cuts”. We’ll see; I hope I’m wrong. Boehner and his leadership team have not shown any appetite for real spending cuts so far.

    • There is also the problem with #4 that the Republicans already tried “shutting down the government” as a tactic in the mid-1990s. To say that it didn’t work out well for them would be a serious understatement. Would they really be foolish enough to go down that road again? Perhaps more to the point, how do they use the threat as a bargaining tool when it is hard for anyone they are negotiating with to believe that they would be so stupid . . . or to see how “I’ll shoot mysel if you don’t give me what I want” is a reason to give in.

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  5. Interim House Bill:

    After reviewing anticipated receipts in the coming months, the House should pass a debt ceiling increase structured as follows:

    1. For February, ceiling increased by up to 70 billion (depending on anticipated receipts), provided however that the President must certify that additional borrowing is essential to meet essential obligations of the U.S. Government.

    2. For March, ceiling increased up to 60 billion (again, depending on anticipated receipts), etc.

    3. For April, up to 50 billion (etc.)

    Under no circumstances shall the President allow the U.S. to default on any debt obligation, or to fail to fund social security, medicaid, VA, essential national or homeland security obligations.

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  7. I wish I shared your faith that this bunch of fools (in Congress) are even capable of acting so intelligently!

  8. Keith,

    You write:

    But it’s irresponsible for the government not to fulfill in a timely fashion legal commitments it has already made. This is about the sanctity of contracts and the U.S. government’s credibility as a party to an agreement. If the U.S. government legally commits to paying someone a benefit, or agrees to pay a firm for a good or a service, the U.S. government should fulfill that agreement in a timely fashion. To do otherwise is taking the first step to becoming a banana republic. The fiscally responsible policy is to pay your bills on time and cut future spending commitments.

    Also note that payment prioritization doesn’t stop payments, it just delays them. Then the aggrieved party sues the government, and probably win…

    My comment at http://keithhennessey.com/2013/01/14/definitions/#comment-7079 applies here as well, perhaps even more so. There is an important distinction you are glossing over, explained in my comment at link.

    • I agree, sort of. I’d separate spending into three categories, not two:

      1. Funds which have already been obligated by the executive branch, but for which the cash has not yet been outlayed.

      2. Funds which have been appropriated by Congress (in an enacted law) but have not yet been obligated by the Executive Branch.

      3. Funds which have not yet been appropriated by Congress and enacted into law, but which may be, and for which additional borrowing would be necessary.

      You’re right that a big debt limit increase would cover (3) in addition to (1) and (2). Not spending funds on (1) would be a breach of contract by the government. Not spending funds on (2) would not breach a contract with a private party, but it would violate the “impoundment” part of the Budget and Impoundment Control Act, which requires the Executive Branch to spend funds enacted into law by an appropriation. That law could be changed before the funds were obligated, of course, without breaching a contract with a private party. But until/unless the appropriations law is changed, the President is right to say that categories (1) and (2) are commitments already made, albeit of different types.

      Great comments, by the way.

  9. This is a good, constructive and responsible suggestion as to how to head off a potentially disruptive impasse.

    Any proposed solution to this “problem” should satisfy three elements:

    1. It should be legal (that should go without saying, but given recent discussions about a platinum coin, it bears repeating);

    2. It should be responsible in that sense that it represents the basis for a reasonable bipartisan compromise and not just political posturing;

    3. It should be responsible in the sense that it at least partially addresses the underlying causes of the need to raise the debt limit in the first place.

    But, actually, your suggestion does not seem to deviate from what appears to be the Republican position. That is, combine an increase in the debt limit that also spells out a reduction in specified items of spending. What this post seems to add, if anything, is that those two items should be combined in a Republican-sponsored House bill. I would agree with that and would simply add: What are they waiting for? The sooner that bill is marked up and voted on, the better.

    I disagree with the literal language of the following:

    “But it’s irresponsible for the government not to fulfill in a timely fashion legal commitments it has already made. This is about the sanctity of contracts and the U.S. government’s credibility as a party to an agreement. If the U.S. government legally commits to paying someone a benefit, or agrees to pay a firm for a good or a service, the U.S. government should fulfill that agreement in a timely fashion.”

    It’s not clear what you mean by “legally commits to paying someone a benefit”. It is clear, in fact very clear, as a matter of law and historical policy that “benefits” such as Social Security, Medicare, unemployment benefits, etc. are *not* “legal commitments”. As a matter of fairness and sound policy, however, any legislative changes to those programs should give those potentially affected sufficient time to plan their financial affairs accordingly.

    • Actually, I think they are when they’re due NOW. If you’re a current retiree eligible for SS benefits, and the government does not send you a check, the government is violating your legal entitlement to that benefit NOW.

      You don’t, however, have any legal claim on future benefits that current law promises you, since that law can be changed at any time. Does that address it?

      • So you are saying that if you are due $900 in SS payment on the 15th of the month then as of today, it is a legal entitlement that I could sue to demand? While if I am expecting $900 tomorrow, then having the prioritization plan enacted today would put any such claim out the window?

        I agree that this is the case, but parsing it so finely is going to be trouble.

      • Yes, that clarifies it. Thank you. But, I don’t think your clarification was compelled by the language I cited above, which quite arguably included making changes to current law that would affect *future* benefits.

        I agree that as a matter of policy and fairness, at the very least, those accrued benefits should be paid. However, Congress can likely, as a legal matter, reduce benefits retroactively. This is despite the Constitutional prohibition against ex post facto laws (applies only to criminal matters) or Bills of Attainder (likely requires a smaller section of affected persons). The retroactive tax on AIG bonuses was recently justified on similar grounds by such Constitutional law luminaries as Laurence Tribe. The problem here, however, is that Congress would not pass a specific law to reduce those benefits but would effectively do so by doing nothing. There are due process problems with that, I think, as well as the Impoundment Act issue you mention, because Congress would not have expressly reversed an appropriation previously made . On the other hand, they would likely be delaying those payments rather than denying them…

        This ties into the observations made by Brooks, above, and your response thereto.

        The idea that people should, as a matter of fairness and good policy, be given notice of changes to major programs such as Social Security and Medicare, for example, simply reinforces the idea that we should act *now* on the problem rather than later. The sooner we act, the longer people have to adjust to the changes. And, those changes will need to come. While many progressive leaders claim we don’t have a deficit problem *now*, but will need to take corrective action within 10 years (as Krugman recently did), this necessarily means we will need to give shorter notice to those affected when the change is forced on us, and/or put more of the burden on younger cohorts. *That* is also not fair.

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