Prairie Muffins: THE U.S. Debt Ceiling

A Reckless Threat: The clock is winding down as the markets anxiously wait for the honorables to make a decision about the government debt ceiling. Here’s the kicker: Even if the latest round of budget talks fail, well-known economist Peter Morici explains why the U.S. does not have to default on national debt and why higher taxes are not needed.

A Reckless Threat: The clock is winding down as the markets anxiously wait for the honorables to make a decision about the government debt ceiling. Here’s the kicker: Even if the latest round of budget talks fail, the U.S. does not have to default on national debt and higher taxes are not needed.

In the debt ceiling talks, President Obama and Republican leaders are locked in a battle of will. Democrats continue to endlessly nag that the $1.6 trillion deficit of 2011 has been caused by profligate spending and tax cuts during the Bush years. Without tax increases, they cry, the U.S. government faces default on the national debt.

Prairie  Muffins!

The simple truth is that higher taxes are not needed and the U.S. does not have to default if no deal is struck by August 2. In 2007, the last year before the financial crisis and (coincidentally) the same timeframe of the Democrat-controlled Congress’ first budget, the federal deficit was only $161 billion … with two wars raging, the Bush tax cuts, and the prescription drug benefits for seniors.

In 2011, during the third year of the “economic recovery,” the deficit is up ten-fold. The difference is $1.1 trillion in new spending … $200 million to accommodate inflation and $900 million in permanent spending increases that were put in place in the guise of temporary stimulus by Democrats. This 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 this deficit increase is found mostly in temporary tax breaks, such as the partial holiday on social security taxes and the incentives for business to invest in new equipment that is scheduled to phase out.

But our country does not need more taxes. Instead, it needs for the President and remaining Democrats in Congress to fess up and accept cuts in spending that the nation can no longer afford.

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

The Democrats want higher taxes on the wealthy and they want to plug 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. Any net deficit reduction would not be large.

Although some loopholes could be plugged, moderate Democrats and Republicans both agree that U.S. corporate taxes are too high for American manufacturers 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 these 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 that are equal to about 55 percent of expenses. This means the interest on the debt could easily be paid, Social Security and Medicare checks could still go out, and the military will be adequately funded. On the other hand, however, other functions would have to be greatly scaled back. This scenario has been endured before and it 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. This will likely include phasing down some operations during the last weeks of July as the early August deadline draws closer. That strategy will take the club away from the President and Democratic leaders in the debt-ceiling negotiations, but strengthen their strategy to continually paint Republicans as spendthrifts.

Sadly, the Republicans remain as inept as ever. For whatever reason, they simply don’t have the sense to debunk Democratic rhetoric with hard facts. Leadership failure by both parties – which is really 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.

Peter Morici

Dr. Peter Morici is a professor in the Robert H. Smith School of Business at the University of Maryland, College Park, MD 20742-1815, 703-549-4338, pmorici@rhsmith.umd.edu, www.smith.umd.edu/lbpp/faculty/morici.aspx.

2 Comments



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  • Jeffrey Banks wrote:

    Well written, Professor. Next time you might want to address the issue that I have not seen addressed: The $250 Billion generated by the tax increase will come from somewhere. What is that money doing now and what are the unintended consequences of pulling that amount of money every year out of the economy and into the government’s hands? Nobody is asking that question…!!

  • john mark wrote:

    Who’s job is lost when taxes are raised on multimillionaires? The pool boys? Please explain how.

    $250 billion dollars ‘not much’! By your numbers it would easily pay the $18 billion. I can live with that.

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