Home >> United States & Canada >> Economics & Trade

     Email   Print 

No Default, Shutdown Not Inevitable if Debt Ceiling Talks Fail

Prof. Peter Morici - 6/30/2011

The United States does not have to default on its debt, and the social security and Medicare checks can go out even if Republicans and President Obama cannot strike a deal to raise the debt ceiling by August 2.

Even though the government cannot borrow additional money, it still has tax revenues equal to about 55 percent of expenses—$2.2 trillion against expenses equal to about $3.8 trillion for a $1.6 trillion deficit. With those tax revenues, Washington can fund interest on the national debt, social security, Medicaid, and crucial national defense responsibilities. With the interest on the debt honored, the government can sell new bonds to replace bonds that come due without piercing the statutory debt limit.

Interest, benefits to seniors and defense would absorb virtually all tax revenues. It would appear the other functions of government would have to shut down, but the Administration has other options.

Often overlooked, the Treasury can print money to pay its bills. Before you gasp that Washington would be flooding the world with greenbacks—it doesn’t have to be.

The Federal Reserve holds on its balance sheet about $2.6 trillion in securities, mostly Treasury bonds, which it could sell to absorb the money the Treasury prints to pay its bills. At $1.6 trillion a year, that could keep the government running past the next election.

Also, since 2007, government spending has jumped $1.1 trillion but only $200 billion was needed to cover inflation—the $900 billion additional was new programs and benefits and higher pay. That has increased federal spending’s share of GDP from 19.6 percent to more than 25 percent.

Temporarily, slicing that additional government spending by $450 billion, by executive order, would likely stand up in court as an emergency measure. Especially if President Obama and Secretary Boehner sat down and did a deal, alone and with no help from their partisan friends but if necessary.

It would be good politics for both sides—either the President is right and Americans would see how painful it is to cut government that much, or Republican would be able to point that we are better off.

The Treasury would have to print about $1.2 trillion a year in new money, and the Fed would sell an equal amount of securities from its balance sheet; however that maneuver would take us until a new Congress is seated and a reelected President Obama or his successor has a clear mandate.

Before you say this is kicking the can again, consider that in 2012, both the President and his opponent would have to table specific alternatives for slashing the deficit and restoring normal operations, and the winner would emerge with a mandate for his plan.

Right now, neither side is tabling credible plans. The president’s taxes on the rich and other schemes would only slash at best $150 billion annually from the $1.6 trillion deficit, and the Republicans about a similar amount in spending cuts they have managed to propose.

Neither side is talking about harnessing the rapidly rising prices the government pays for health care—both sides just talk about trimming benefits a bit or the pain of it.

The United States pays double, or more, than European governments for drugs, and suffers from large disadvantages in insurance administration, hospital efficiency and tort costs. Regulating those prices is tar baby no one in Congress or the White House wants to put his arms around—but we are not getting out of this mess without doing so.

Ditto for retirement ages for social security and the vast array of federal pensions, and state pensions the federal government indirectly helps finance.

The absence of frank discussion of financing options beyond August 2 is the fault of two men. Though Treasury Secretary Geithner serves at the pleasure of the President, and Fed Chairman Bernanke must answer frequently to Congress, both men have a responsibility to articulate the genuine budget and economic challenges before the nation, and both men can easily find other satisfying and better paying jobs in a pinch.

In similar crises, past cabinet members have stepped up—consider the conduct of senior Justice Officials in the last days of the Nixon Administration, and Alan Greenspan was not afraid to talk frankly about federal policies.

Secretary Geithner needs to draft plans to keep the government going and be quietly frank with political leaders about those plans. And, Chairman Bernanke would then concur with how the Fed can respond.

Sadly Geithner and Bernanke are shirking responsibilities. Geithner’s substantive shortcomings are widely speculated; however, Mr. Bernanke is a bright man and has no alibis to offer.


In the debt ceiling talks, President Obama and Republican leaders are locked in a battle of will. The simply truth is higher taxes are not needed, and the U.S. does not have to default if no deal is struck by August 2.

Democrats endlessly nag the $1.6 trillion 2011 deficit is caused by profligate spending and tax cuts during the Bush years, and without tax increases the U.S. government faces default on the national debt.

Prairie Muffins!

In 2007, the last year before the financial crisis and Democrats Congress’s first budget, with two wars ragging, the Bush tax cuts, and the prescription drug benefits for seniors, the federal deficit was only $161 billion.

In 2011, in the third year of economic recovery, the deficit is up ten-fold. The difference is $1.1 trillion in new spending--$200 to accommodate inflation and $900 in permanent spending increases put in place in guise of temporary stimulus by Democrats. That includes greatly enhanced Medicaid eligibility, an explosion in regulation that is failing to boost U.S. energy production and curb Wall Street abuses, and industrial policies that were supposed to create millions of new jobs.

The balance of the increase is mostly temporary tax breaks like the partial holiday in social security taxes and incentives for business to invest in new equipment scheduled to phase out.

The country doesn’t need more taxes, it needs for the President and remaining Democrats in Congress to fess up and accept cuts in spending the nation can’t afford.

Prior to the financial crisis, GDP grew about 2.9 percent a year, and now it is creeping along at closer to 2 percent. It doesn’t take rocket science to see that jumping federal spending from 19.6 percent of to close to 26 percent in 2011 is not a pro-growth strategy.

The Democrats want higher taxes on the wealthy and plugging some corporate tax loopholes but that simply won’t do it. The president’s budget already assumes repeal of the Bush tax cuts for those earning over $250,000. Even raising income taxes by 50 percent on all families earning more than $200,000 would not yield much more than $250 billion a year. The resulting capital flight would reduce taxable income, and job losses would drive up federal social spending—net deficit reduction would not be large.

Although some loopholes could be plugged, moderate Democrats and Republicans agree U.S. corporate taxes are too high for American companies to be competitive. Most revenue that might be found fixing abuses will eventually have to be put into lower corporate taxes for those firms bearing more than their fair share of the burden.

If budget negotiators can’t focus on those facts before August, the U.S. government is facing a shutdown—something it has endured in the past—but it does not have to default on the national debt.

Default is a reckless threat.

The U.S. government will still be collecting taxes equaling about 55 percent of expenses—and interest on the debt could easily be paid; social security and Medicare checks could go out, and the military adequately funded. Other functions would have to be greatly scaled back. This has been endured before and is not pretty, but make no mistake about it, we have plenty of money on hand to pay $18 billion each month in interest on the debt. With a sound plan to manage the crisis, bonds coming due could be rolled over.

Secretary Geithner, whose primary skills are bureaucratic and not economic, appears intent on forcing a crisis rather than making plans to keep the country going. That would likely include phasing down some operations the last weeks of July as the early August deadline draws closer.

That would take away the President and Democratic leaders club in the debt-ceiling negotiations, and their strategy to continually paint Republicans as spendthrifts.

Sadly, the Republicans as inept as ever, don’t have the sense to debunk Democratic rhetoric with hard facts.

Leadership failure by both parties—an inability to face facts—is why the U.S. government is facing default.

Avoiding default does not require more taxes, and default doesn’t have to happen if Democrats won’t accept a deal without higher taxes.