Stalemate on the Debt Ceiling?

by Philip Brewer on 29 April 2011 10 comments

The news is full of speculation about the result if there's a stalemate on the debt ceiling, but I know what would really happen. I live in Illinois.

You see, Illinois has been in much the same situation for years now. The legislature has appropriated more in spending than they raise in taxes, but there are sharp restrictions on how much money the state can borrow. (See also: Borrowers, Lenders, and Others — Beware Trusting the Government)

So what happened? Well, interest on our debt got paid. State employees' salaries got paid. State pensions got paid. Tax refunds got paid. Unemployment checks got paid. Direct benefits like food stamps got paid.

Who didn't get paid? Anyone who did business with the state. The state quit paying its bills. Business and contractors who provided services for the state got stiffed for months, and the state is by no means caught up on paying its bills (even though it recently raised taxes).

I'm confident that, if there's no increase in the debt limit for the federal government, the result would be much the same. There are a number of temporary measures the Treasury would take first — redeeming some debt owed to states, cities, and federal retirement funds — but once it exhausted those maneuvers, it would have to stop making some budgeted payments. But the Treasury would be deciding which payments to make and which to delay. The effect would be to give Treasury Secretary Geithner complete control over who gets paid when.

As I read it, there is only one constitutional requirement for federal payments — judges have to get paid. After that, if there's not enough money, the Treasury can pretty much pick and choose.

I'm sure the Treasury would pay the interest on the debt, because the public debt of the United States is what it cares about most. It'd also go ahead and roll over maturing debt (staying under the ceiling). It would go on paying military personnel and government employees. It would go on paying social security, railroad pensions, and other direct payments to individuals.

What the Treasury would quit doing, just like in Illinois, is paying contractors. It wouldn't refuse to pay them, it just wouldn't cut a check until the money came in. (It would rack up late-payment charges, but neither those nor the unpaid bills themselves count against the debt ceiling.)

In Illinois, where this went on for years, the government didn't just pay the bills in order. They gave priority to businesses that might fail if they didn't get paid. (Lots of businesses that contracted with the government to provide services to the poor had no non-government business. If they didn't get paid, they would be out of businesses in a matter of a weeks.) There was a whole procedure in place for businesses to make urgent claims for relief. If the situation went on at the Federal level for any length of time, I'm sure the same sort of thing would happen.

Think of the power this gives the Treasury! I'm sure they wouldn't do anything so crass as to pay companies that were donors to their party before paying companies that donated to the other party, but I wouldn't be surprised to see the power brought to bear only a little more subtly than that. For example, employers in a state where a senator was blocking a bill to raise the debt ceiling might have particular trouble getting their bills paid.

Personally, I don't think that situation would go on for very long. When the many large companies that do business with the United States quit getting paid, they'd have a quick chat with the Senators from every state where they have an office. When the many, many small businesses that have contracts with the federal government quit getting paid, they'd call up their Representatives and make it clear that they wanted the problem fixed. Most especially, once members of Congress realized that what they'd done was to hand the power of the purse over to the Treasury — give Timothy Geithner the power to decide who gets paid and who doesn't — they'd raise the debt ceiling and grab that power right back.

These insights brought to you thanks to my long experience living in Illinois.

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Guest

Couldn't the Treasury just mint more money? Inflation is a bad way to handle it, but there would definitely be that pressure from the contractors.

Philip Brewer's picture

Preventing that is a big part of the reason things are set up the way they are—with the central bank separate from the Treasury.

If the Treasury couldn't borrow money (because lenders didn't trust the US to pay the money back), then you'd expect things to go along the course you outline—the Treasury would issue debt, the central bank would buy it (with newly created dollars), and then the Treasury would spend the new money. That would cause inflation and lots of it.

At the moment, investors seem to be quite willing to buy Treasury securities. The problem with the debt ceiling is that Congress has told the Treasury to spend money (by appropriating it) but isn't raising enough in taxes to cover the bill—and is telling the Treasury not to borrow it either.

Guest's picture
Josh

The debt ceiling for the federal government is nothing like the debt ceiling for Illinois. I know to the casual observer that this might seem to be the case but it is not. The Illinois does not have Defense, Social Security, and Medicare as it's largest spending items. If the debt ceiling is not at least temporarily raised it will force the government to do one of two things:

1. Default on its debt which would drive us into the next great depression.
2. Start paying our bills on a month-to-month plan which would provide us less money than we need to fund defense, Social Security, and Medicare alone much less everything else. We would certainly stop paying contract workers as well as military workers along with most of Social Security and Medicare. We would see government contract works and government workers lose their paychecks. This would take our current unemployement rate up by at least another 18% again causing another depression.

While you mental short cuts are easy to make you need to look at the shortfall and where our federal money is spent. Contract work is a very small portion of our national budget, certainly much smaller than this years shortfall. So unlike Illinois if the our elected officials believe the same thing would happen, they could very well crash our economy much worse than the banks did.

While we need to raise taxes, cut spending on Defense, Social Security, and Medicare in the long run letting us hit the debt ceiling to protest our unacceptable deficit is the wrong thing to do. It would cause a disaster from which we would not likely recover.

Philip Brewer's picture

Oh, I agree with you on the policy prescriptions. Congresses is living a preposterous fantasy when it appropriates spending in excess of taxes and then refuses to raise the debt limit. It show all the maturity of a 6-year-old.

I think you're wrong, though, about the size of the "contract" work as a fraction of the Federal budget. For example, most of the defense budget (basically, everything except salaries) are obligations of the sort that I figure will get deferred. Military contractor companies won't get paid, defense contractors won't get paid, landlords won't get paid, companies that perform maintenance or supply spare parts won't get paid, companies that provide water and food won't get paid, companies that supply fuel won't get paid, etc. There's a lot of money there.

Obviously there are limits. I mean, the pure defense contractors would have to just suck it up, because what else are they going to do? But companies that have the choice between selling to the Federal government and selling to firms that actually pay their bills might well tell the government that it had to pay cash in advance or there'd be no more shipments. (I'd expect the government to have to start paying cash for fuel, for example.)

I'm certainly not advocating this strategy. I'm just saying that the result would not be a disaster—less like a slow-motion train wreck than like a slow-motion special effect of a train wreck.

Guest's picture
Josh

Alright, i'll make the math easy for you. Go here http://www.usgovernmentspending.com/budget_pie_gs.php?span=usgs302&year=... and you cut the $1.6 Trillion by cutting contrat workers and special programs. Even if you could, which you can't you are pulling $1.6 trillion out of the economy and expecting it not to crash jobs and GDP. The numbers simply do not add up. I'm sorry but the more you understand about this, instead of just guess according to your previous experience in another matter, the more you realize that it will crash our economy. Here is a breakdown of the military budget remeber it includes service on its debt, paychecks for military families, a few overseas operations, base upkeep, and a few other things you can't cut even if you did decide to put all millitary contract workers out of business (which you really can't because there are a decent number of them helping us fight in overseas engagements) http://en.wikipedia.org/wiki/Military_budget_of_the_United_States. So work on the numbers and come back to me when you've figured out how to hit the debt ceiling and not send us into a depression. This is not an issue of putting your finger to the wind and feeling something is right, it is a math problem and there is only one right answer.

Philip Brewer's picture

Sure. None of that is new to me. And yet, I still think it would play out about as I'm saying.

For example, it's not the contract workers who aren't getting paid—it's the contracting firms. Yes, there are many individuals overseas helping with war efforts, and they'd still be getting paid by the firms that employ them. Those firms, however, would be squealing because their invoices would be sitting unpaid in some queue at the Treasury. What are those firms going to do? Well, the same thing every other firm does when its bills don't get paid—they'd complain, they'd charge late fees, they'd sue, they'd eventually quit providing services (or else go bankrupt). But none of that causes a depression, nor does any of it cause the US to default on its debt. It probably wouldn't even hamper our war-fighting efforts in the short term. (It would eventually, when the companies decide that they'd rather not be in the business of providing services for a client that doesn't pay. Or go broke because they aren't getting paid. But that's a long way off. And the US could forestall such moves by trickling out just enough money to keep each individual firm from going bust.)

Ditto with health care. The US wouldn't be eliminating Medicare. It'd just be slow about paying its bills. What would doctors and hospitals do? Same as the military contractors—complaints, fees, lawsuits, and eventually going broke. VA hospitals would still pay their doctors and nurses, they'd just be late paying the pharmacies for drugs. What are the pharmacies going to do? Cut off drugs for injured vets? Eventually, perhaps, but most will just suck it up and wait for the political process to push through the needed fix (while leaning on their Senators to do just that).

Now, if things stretched on so long that large numbers of firms started going broke because they weren't getting paid, that'd be a big deal for the economy. But a few months of late and partial payments wouldn't harm the economy; it'd harm businesses who provide services for the government. Happily, the owners of such businesses are the sort of people who have political pull. They'd talk to their Congressmen and get things fixed quite quickly, long before the economy took much of a hit.

Guest's picture
Josh

I don't think your lookiing at the numbers. We would have to immediately stop all defense spending and all medicare and medicaid spending in hopes of not hitting the debt ceiling which we are scheduled to hit by July at the latest. That means defaulting on military debt, stop paying all military salaries for the armed forces, stop funding the overseas operations completely, and we might barely squeek by except for the fact that those changes would mean that quarterly estimated tax payments would dramtically decrease because of all the people not receiving money and all the member of armed forces not getting paid anything. There is no trickle to keep things afloat we are speaking defaulting on military debt and laying off armed service members. Our system is based on the good faith of the US government. If no one is getting paid no one has any faith. This means no one would accept any cases from medicare and medicaid which would not be payig anything anyway. 1.6 trillion is the entire budget for health and defense not part of it. This is not a blip on the screen, this is the fall of Rome, complete destruction. Even if we split it up by laying off half of teachers nation wide, half of armed forces, all defense contractors, half of transportation, all of general government, we stopped welfare completely, and we told people they would only receive half of their Social Security checks we would still not cut enough to avoid hitting the debt ceiling this year because of the dramatic reduction in tax income from all the people who were laid off and are no longer paying taxes (not to mention all the people who provide services to employees that would lose their jobs because there would not be enough employees buying things to support their salaries). Like I said before we would under any circumstances likely increase the unemployement rate by at least another 18% in the best of scenarios. Though we would probably see a pretty large increase in profits for undertakers from all the destruction it would cause. As I mentioined before the other option is to default on our debt and watch the dollar become worthless paper. Both create massive death and destruction.

Philip Brewer's picture

Rather than persisting in going back and forth, let me just say this:

The problem with the debt ceiling is not a financial one, it's a political one. Happily, I think the first people to feel the pain if the debt ceiling is not raised will be people who have considerable political power—major corporations, large numbers of small businessmen, etc. The upshot, I predict, will be that the political problem will be fixed quickly—well before there's any significant damage to the economy.

Guest's picture
Josh

Here's a 58 second video that does a pretty good job explaining the math and breaking it down to much more simple terms: http://www.salon.com/technology/how_the_world_works/2011/05/20/why_the_d...

Even if you cut everything but SS and Medicare you would have to raise the debt ceiling to pay for SS and Medicare because the depression that would be caused would decrease taxes paid and the government till would decrease to the point it could not even support SS and Medicare.

On a side bar I thought you play around with the budget to better understand the math behind it. Here's a tool: http://crfb.org/stabilizethedebt/ the goal is to stabalize the debt to 60% of GDP by 2016. Have fun!

Philip Brewer's picture

I've seen that video. It's excellent.

Not raising the debt ceiling would result in just the sort of result described—bills would go unpaid because there wasn't any money. And not just "discretionary" expenses, but bills to pay for core government responsibilities.

I particularly like the last bit in the video, because it zeros in on what I think is the central truth about the whole matter: The result would be to give the Treasury the authority to decide what got paid and what didn't. Congress would never stand for that. Which means that the debt ceiling will be raised—either before bills start going unpaid or else very shortly after.