Raise The Roof

A debt-ceiling hike would avoid California-style budget woes

Failure to pass a timely debt limit increase will expose our country to economic risk. But it is not exactly the same risk that many people in Washington think.

The federal government is on the cusp of hitting the statutory limit of how much debt it may have outstanding � $14.29 trillion. President Obama warns that Congress must raise this limit or risk triggering a “worldwide recession.” He’s referring to the most-discussed debt impasse scenario: The government fails to make an interest payment on its bonds, and a financial panic ensues.

This would indeed be a huge problem, but it is not terribly likely. We’ve muddled through several debt limit impasses in the recent past, including in 1985, 1995-96, 2002 and 2003. In each case, the executive branch has used creative accounting measures to stay within the debt cap while cajoling Congress to approve an increase. The outcome of the current crisis is overwhelmingly likely to be the same � no default, eventual compromise, no disruption in the markets.

But there is another bad outcome that is more likely: A debt limit impasse could lead Washington to come down with a chronic fiscal illness, wherein we adopt some of the worst fiscal practices of state governments. The question is whether the administration will be forced to resort to what might be called payment prioritization in order to make interest payments � that is, strategically delaying or defaulting on government obligations other than the debt.

Having too little money to pay the bills and no authorization to borrow more is an unusual situation in Washington; it is everyday business in Sacramento and Springfield. If Congress gets too fond of holding the debt limit hostage as a fiscal policy tool, we risk the California-ization of federal budgeting, and the higher borrowing costs and greater policy uncertainty that come with that.

At first, payment prioritization won’t be necessary. Treasury Secretary Timothy Geithner has announced that “extraordinary measures” � mostly, borrowing money from federal employee retirement funds and other government trust funds (but not those for Social Security and Medicare) will be enough to get us to Aug. 2. After that, Treasury would likely have to start sending IOUs to some government payees.

While Treasury has warned that it “lacks formal legal authority to establish priorities to pay obligations,” the Government Accountability Office has reported otherwise, stating that “Treasury is free to liquidate obligations in any order it finds will best serve the interests of the United States.” Treasury has obvious reasons to downplay its powers here � it wants to convince people that a timely debt limit increase is imperative � but when push comes to shove, Geithner can be expected to pay the interest bill before other government expenses.

Republicans in Congress have talked about payment prioritization as a useful option and a reason not to be too worried about a failure to raise the debt limit. But we’ve seen how this process works in California, where state workers were paid with IOUs for part of 2009, and in Illinois, where the state has approximately $8 billion in unpaid bills owed to local governments and contractors, such as Medicaid providers.

Such strategies have indeed allowed California and Illinois to avoid defaulting on their debt and even retain access to the bond markets. But the problems with simply not paying your bills are obvious, and they grow more severe the longer an impasse lasts. California and Illinois pay among the highest yields to borrow money among U.S. states, and irresponsible fiscal practices like these are one of the reasons why.

This isn’t a good model for the federal government to mimic. The best course would be for Congress to avoid a cash shortfall by passing a clean debt limit increase � or simply abolishing the debt limit altogether.

Of course, members of Congress should concern themselves with the size of government and should enact budget plans that resolve our long-term fiscal imbalance. The same Republican majority that has the option to hold up the debt limit increase now will have to pass whatever budget and appropriations bills determine government spending in the years 2012 and beyond.

This year’s budget fight � which started last month with the release of the budget proposal from Rep. Paul Ryan, R-Wis. � is the right venue for such reforms, not the debt limit increase that is needed this spring.