Raise the debt limit and cut spending
by Keith Hennessey
14 January 2013
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.
- 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.
- 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.
- 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.
- 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.
- Rely first on the sequester, second on the CR, and last on the debt limit as leverage.
- 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.
- 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.
- 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.
- 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.
- 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.
- 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.