The US Debt-Ceiling Debate

I.                    Introduction: Why the Debate on the Debt Ceiling is Valuable

What does the US debt-ceiling debate have in common with an ancient Dutch village? On the surface, not much; but there is one common theme between the two during the negotiation of imminent disasters. “Polder Politics” is the term used to describe the negotiations that Dutch villages would undertake to build sea walls in order to prevent flooding in their communities; all had to cooperate, or be drowned (Beattie, 2011). The United States is facing a similar predicament, though the American version is self-inflicted and financial in nature.

On a fundamental level, if the debt ceiling is not raised, the US government will have a “technical” default on its debt. It is considered technical, whereas the default in Greece is a debt services default. The difference is that Greece cannot pay its bills, but the US would effectively be choosing not to. To (non-fiscally conservative) Democrats and many overseas, this seems silly, much like a billionaire refusing to pay the mortgage on his home. To Republicans, this is an opportunity to do two things: improve their position heading into 2012 and solve some previously intractable financial problems. To the Tea Party, the Club for Growth and a number of other groups, this truly is political war. The vast differences between these groups is making negotiation very difficult and has driven the cost of insurance against a US default to a record high (Mackenzie & Bullock, US insurance hits record, 2011). What this means for the average person is that whatever company is managing your retirement plan is losing money because of the political crisis. This eventually translates into a loss of money for your portfolio aka less money for you in retirement. This is only one reason the debt ceiling debate is important and why it needs to be resolved quickly.

 II.                  Consequences for a Failure to Raise the Debt Ceiling

  • US money-market funds are “stockpiling cash” for the potentiality that Congress decides not to raise the debt limit. They are particularly concerned that a failure to agree by the deadline could spark massive investor redemptions, similar in function to a run on the banks. Additionally, the stockpiling of cash causes money-market funds to hold assets (such as cash) that are unprofitable and lower returns for investors (McCrum, 2011).
  • The Federal Aviation Administration (FAA) is now underfunded and unable to collect taxes on airplane tickets, which has caused the agency to put 4,000 employees on temporary leave. The taxes are used for airport improvements and the salaries of non-essential workers (McGregor, 2011).
  • Social Security and other entitlement paychecks will not go out. In reality, politicians on both sides of the aisle are unlikely to let this happen.
  • The US could lose its AAA credit rating, which would create a huge disturbance in the financial world, which you would notice in terms of interest rates that you would pay or receive on credit card APRs, savings account interest, car loans, mortgages etc. That is only a small portion that the average person would notice. Simply put, this one event could literally change the way the world works.

 III.                 Politics

Democrats’ Plan:

The first approach says, let’s live within our means by making serious, historic cuts in government spending. Let’s cut domestic spending to the lowest level it’s been since Dwight Eisenhower was President. Let’s cut defense spending at the Pentagon by hundreds of billions of dollars. Let’s cut out waste and fraud in health care programs like Medicare — and at the same time, let’s make modest adjustments so that Medicare is still there for future generations. Finally, let’s ask the wealthiest Americans and biggest corporations to give up some of their breaks in the tax code and special deductions” (Obama, 2011). The Senate Democrats actually submitted a plan with limited detail on July 25, 2011 that primarily included reductions in spending from defense, agricultural subsidies and federal pension programs as well as “winding down the wars in Afghanistan and Iraq” (Senate Democrats, 2011). A portion of Reid’s plan that differs from Boehner’s is that it attempts to address problems with Fannie Mae and Freddie Mac (Korte, Kucinich, & Jackson, 2011).

Republicans’ Plan:

The Republicans  seek a multi-tiered approach to the conflict, seeking to extend the debt limit only through the beginning of next year (2012) to be followed by comprehensive reform of long-term spending (Mackenzie, Politi, & Beattie, 2011). House Majority Leader Eric Cantor stated “In this new framework, we will achieve spending cuts that exceed the amount of the debt limit increase, cap spending for the next ten years and offer a path to achieve serious reforms through a bipartisan, bicameral commission” (Cantor, 2011). One interesting component of the Boehner plan is the spending caps put in place which marks an arbitrary line in increased spending, which once crossed, triggers automatic spending cuts across the board to compensate for the new spending (Korte, Kucinich, & Jackson, 2011).

Democrats’ Goal:

Because of the fiscal mood in the US, political risk for the Democrats is higher, so they must make some concessions, including removal of their demand for tax increases, but most likely any deal will include little more in new revenue than the closure of loopholes and elimination of some corporate and agricultural subsidies, a concession the fragmented GOP could live with in order to finalize a deal. Additionally, the Democrats need to try to get a larger increase in the debt ceiling to put off a politically unfavorable topic. They are hoping for an increase of $2.4T which would put off a new fight over the debt ceiling until after the 2012 elections (Politi & Mackenzie, 2011). This may be even more important for Obama’s 2012 reelection hopes since the president is generally credited with the state of the economy in real-world terms of polling and voting. The American public has typically held that office responsible for overall economic growth…or the lack of it (Cannon, 2011). “It is manifestly preferable to make concessions to the Republican right than to risk the consequences of a US debt default” (Kay, 2011). Kay is speaking here primarily as an economist, but the avoidance of default is clearly important politically for the Democrats as well.

Republicans’ Goal:

The Republicans need to gain major concessions on entitlements from Democrats at the last minute without tax increases and play for 2012. Waiting until the last minute will appear to make them look like they had no choice but to take the best deal they could negotiate with the Democrats or risk major financial problems. This appearance is necessary cover for some with more fiscally conservative constituencies, who may consider making any vote for a tax increase a betrayal. They also want to raise the debt ceiling by only $1T, which will create a new fight over raising the debt ceiling again in early 2012. This will be likely to favor Republicans politically going into a presidential election year, by controlling the debate over the economy (Politi & Mackenzie, 2011).

 

Key Talking Points:

President Obama:        “The Republican party is going to have to ask itself, can they say yes to anything?” (McGregor, 2011).

Speaker Boehner:        Obama is “trying to set up a no-win situation for taxpayers: either he gets his $2.4T blank check, or America defaults” (Mackenzie, Politi, & Beattie, 2011).

Fiscal Conservatives:   “Washington wants a deal, Americans want a solution” (Korte, Kucinich, & Jackson, 2011). Quote is from Rep. Jim Jordan (R-OH) and head of the Republican Study Committee.

 

Key Party Concerns:

Democrats:               If tax increases are not included, retirement programs will likely be “eviscerated” (The Economist, 2011). Democrats are concerned that many people who are currently on federal pension and healthcare programs will be unable to survive financially, creating new problems such as mass foreclosures and evictions from homes and potentially civil unrest.

Republicans:             If taxes and the debt ceiling are raised to reduce the deficit, won’t they merely fuel more spending in the future? (The Economist, 2011). The philosophy is similar to how a credit card company might look at a request to raise the credit card limit of someone who has already “maxed out” their credit card.

An Additional Consideration

Many have reported that companies are holding cash, rather than spending it, due to the economic climate. A recent report from Moody’s research shows that companies are holding cash overseas because they do not want to pay a 35% repatriation tax in the US just to bring the money into the country. The Chief Financial Officer of Honeywell told the Financial Times that the United States has “an outdated tax code that basically rewards companies or incentivizes companies to keep cash offshore” (Thomas & Lemer, 2011). The US corporate tax rate, at 35%, is one of the highest in the world. From an economics perspective, companies facing high taxes are likely to look at other nations with more favorable tax rates when they consider building new plants and profit-generating investments. Making the tax code more competitive would not only bring more tax revenues back to the US, but could put many Americans back to work. Fortunately, the US Senate Finance Committee considered this very issue on July 28, 2011, inviting corporate executives to ask them if they would be willing to give up certain subsidies to industry if the overall tax rate was reduced (Cohn, 2011). Tackling this issue soon is important, not only for revenue, but for employment. In sum, the political party that focuses on making America more economically competitive with emerging markets will have a political edge in 2012, not only in terms of corporate fundraising, but from the ability to shape the critical unemployment debate.

 

References

Beattie, A. (2011, July 27). A double act of self-inflicted crises. Financial Times , p. 9.

Cannon, C. M. (2011, July 27). RealClearPolitics – 10 Reasons Each Side Thinks It Can Win the Debt Debate. Retrieved July 27, 2011, from http://www.realclearpolitics.com: http://www.realclearpolitics.com/articles/2011/07/27/10_reasons_each_side_thinks_it_can_win_the_debt_debate_110730-4.html

Cantor, E. (2011, July 25). Congressman Cantor Statement on House Republicans’ Debt Limit Plan. Retrieved July 27, 2011, from http://cantor.house.gov: http://cantor.house.gov/press-release/congressman-cantor-statement-debt-limit-plan

Cohn, M. (2011, July 28). Senate Examines Lowering Corporate Tax Rate. Retrieved July 28, 2011, from http://www.accountingtoday.com: http://www.accountingtoday.com/news/Senate-Examines-Lowering-Corporate-Tax-Rate-59353-1.html

Kay, J. (2011, July 27). Kipling’s game theory lessons for Greece. Financial Times , p. 9.

Korte, G., Kucinich, J., & Jackson, D. (2011, July 26). Obama, Boehner take cases on debt limit to nation. Retrieved July 28, 2011, from USAToday.com: http://www.usatoday.com/news/washington/2011-07-25-boehner-reid-debt-tax-hikes_n.htm?csp=34

Mackenzie, M., & Bullock, N. (2011, July 28). Insurance cost against US default hits record. Financial Times , p. 13.

Mackenzie, M., Politi, J., & Beattie, A. (2011, July 26). Investor fear rises over US gridlock. Financial Times , p. 1.

McCrum, D. (2011, July 27). Funds stash cash as D-day looms. Financial Times , p. 1.

McGregor, R. (2011, July 26). Republicans show no sign of budging in dangerous drama. Financial Times , p. 4.

Obama, B. H. (2011, July 25). Address by the President to the Nation. Retrieved July 27, 2011, from http://www.whitehouse.gov: http://www.whitehouse.gov/the-press-office/2011/07/25/address-president-nation

Politi, J., & Mackenzie, M. (2011, July 28). US debt plans in chaos. Financial Times , p. 1.

Senate Democrats. (2011, July 25). Fact Sheet: 100% of Spending Cuts in Reid Debt Reduction Plan Were Supported by GOP. Retrieved July 27, 2011, from http://democrats.senate.gov: http://democrats.senate.gov/2011/07/25/fact-sheet-100-of-spending-cuts-in-reid-debt-reduction-plan-were-supported-by-gop/

The Economist. (2011, July 2). Lexington: Bargaining and Blackmail. The Economist , p. 28.

Thomas, H., & Lemer, J. (2011, July 28). US groups blame tax as cash held overseas tops $500bn. Financial Times , p. 13.

About Barry Saturday

The author is a Lexington, Ky-based financial advisor and formerly taught high school social studies for Fayette County Public Schools. Along with a M.A. in Education, his educational background consists of a B.A. in Foreign Languages and International Economics and an M.A. in Diplomacy with a concentration in Global Commerce. In 2012, he finished a two-month stint student teaching in Xi'an, China, and recently (2018) ran for City Council in Lexington, KY (District 4: Tates Creek / Nicholasville Rd area). Today's news outlets profit most from incendiary, surface-level appeals to emotion, which is poisoning much of our political discourse nationwide. Barry created this site in order to learn more about our world and share that knowledge with others. He hopes this site, aimed at an educated audience, will provide objective information for those seeking greater clarity and understanding than is often available in the current news environment. If you like what you see, feel free to comment and share with your network.

One Response to “The US Debt-Ceiling Debate”

  1. I intentionally left out both Senate Minority Leader Mitch McConnell’s (R-KY) plan to raise the debt ceiling automatically as well as the original US House of Representatives plan called (Cut, Cap and Balance) which included a balanced budget amendment because both ideas were unlikely to be included in the final settlement. Should Washington have included them?

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