Kurt Davis Jr. argues that the U.S. Congress should consider switching from a federal debt ceiling as a nominal value to one fixed as a percentage of GDP. This debt ceiling should, on the one hand, be high enough that the government cannot reasonably cross it, but punitive enough that it disincentivizes profligate spending. This will save the U.S. from the annual political theater that occurs around debt ceiling talks and focus the discussion on the federal budget (and potentially taking revenue and spending decisions to actually control the deficit).
The United States has a budget problem. The debt ceiling discussion has become a bad proxy for fixing it.
First, the debt ceiling is the amount of debt the U.S. can borrow to pay for spending that has already occurred. Linking this debt limit with next year’s budget sounds more like partisan gamesmanship than anything else–nonetheless this path has been pursued multiple times in the past.
Secondly, even with partisan gamesmanship, the sense of desperation (if associated with the budgeting process) may be appropriate.
The budgeting process has clear flaws…
The process lacks transparency with its opaqueness and outright confusion: the congressional structure of appropriations and authorizing committees includes hundreds of subcommittees with overlapping and potentially conflicting jurisdictions.
A mix of term limits and limited powers for budget committees mixed with the turnover in the House of Representatives further complicates this structure. Simplifying the structure (i.e., reducing committees) and ensuring that committees oversee both revenue and expenditures of key programs would be a great start.
Addressing the lack of long-term focus in the committee debates could increase efficiency. The budgeting process tends to focus on short-term issues with heated exchanges on 20%-30% of the expenses in the budget—generally the “easier” aspects of social programs to discuss publicly—and 0-5% of revenue.
Unsurprisingly, one of the most contentious debates in the recent debt ceiling discussion was centered on stricter work requirements for people seeking food stamps and other social benefits. Americans like laws that prevent people from “stealing from the system.”
Tax increases were off the table while the debt ceiling agreement included a cut to the IRS budget by up to $21.4 billion over the next three years—a significant portion of this money was to be used for increased enforcement and technology. The importance of these issues cannot be understated.
Nonetheless, the more provocative matters of social assistance programs, including Medicaid and social security, infrastructure, defense & national security, and taxes are long-term issues that cannot be avoided if the U.S. is to fix its budgeting process and address the debt problem.
Lastly, the debt problem is inherently a result of budget deficits over time and a lack of accountability. That does not mean public debt is inherently bad. The U.S. government can use borrowing to make investments today that yield economic benefits tomorrow and create growth for the country over the long-term. A short history lesson will show that the U.S. has used debt to fund the recovery from economic crises (i.e., the Covid-19 pandemic downturn, 2008 recession), build infrastructure, fight World War II and achieve victory in the Cold War, and so much more. Accordingly, the American public can appreciate why its government may need to borrow for such things.
It is, however, also clear that an increasing segment of the voters and their representatives believe deficit spending is growing without justifiable economic benefits. In other words, existing and projected spending are beyond the level of current and expected revenues. It is why the Congressional Budget Office, among other organizations, spend significant time and money analyzing whether a bill will increase or decrease the deficit in the long-term. This keen focus on “structural deficits” over time also highlights the growing concern over what is the sustainable debt level for the U.S.
The debt ceiling is a bad proxy for addressing a budgeting issue (and managing American debt)…
The debt ceiling discussion is a self-imposed yearly debate that has become a theater for political hostility.
Many of these discussions have been laden with serious concern of potential default due to the political gridlock. Such partisan rancor and threats in 2011 led S&P to downgrade the U.S. federal government credit rating, adding that the agreement at the time did not stabilize “medium-term debt dynamics.”
Amid the recent discussion, Moody’s warned that a brief default (even for a few days), would shift views on the debt ceiling gamesmanship from political soap opera to real risk, which would ultimately need to be reflected permanently in the rating. For many observers, it was a not so veiled threat of a downgrade.
It is easy to understand that playing around with potentially defaulting is not a sign of being creditworthy.
S&P and Moody’s will also tell you that maintaining a sustainable level of debt is equally important for creditworthiness. However, the U.S. version of a nominal value for a debt ceiling is out of step with the rest of the world and not exactly efficient for maintaining a sustainable debt level.
Few countries have a debt limit in nominal terms. Denmark is one of those countries, which has a debt limit as a nominal value. The Danish debt ceiling was first created in 1993 and has only been amended once. It was raised in 2010 to DKK 2,000 billion or 115% of the 2010 Danish GDP. In 2023, Denmark’s government debt is DKK 327 billion, or 16% of the debt ceiling. The 2010 debt ceiling increase, which doubled the limit, was implemented to avoid any fiscal issues as the government executed ongoing spending and related efforts in response to the 2008 recession.
Kenya is another country with a debt ceiling as a nominal value, but it is currently in the process of switching to a debt ceiling as a percent of GDP.
The group of countries with a debt ceiling as a percent of GDP also includes Pakistan, Malaysia, Poland, and Namibia. The sad reality of this group is that most have failed to stay within measures. Pakistan is currently around 75% with a debt ceiling set at 60%, albeit without any clear punishment for breaching the limit. Malaysia currently hovers above its debt ceiling of 60% with Prime Minister Anwar Ibrahim promising to reduce the country’s debt. Namibia is currently around 72% with a debt ceiling of 35%.
The European Union has a policy that member states cannot have debt that exceeds 60% of GDP with the excessive debt procedure automatically launched by the European Commission if there is a breach. The procedure includes several steps intended to pressure the breaching state to return to the 60% level. Most other nations, including the U.K., Japan, Canada, China, and India, do not have a debt limit. The U.S. surely, based on a demonstrated penchant for spending, should not scrap the debt ceiling altogether. Serious consideration, however, should be given to the EU model.
The ceiling as a percent of GDP can be established at a level sufficient to avoid it plausibly being crossed and ensure the U.S. can sustainably pay its debt. Some excessive debt reduction procedures should automatically start if the limit is crossed. Those measures should be adequately punitive to the effect that they properly incentivize both parties to avoid the demarcation line.
The American public (and investors) expect better…
Americans know the U.S. budget is not like their family household budget. They also know that the US collects sufficient tax dollars to pay its bills and that defaulting would drastically weaken the U.S. position as one of the world’s leading economies.
Americans (and investors in America) also believe the normal script of political bickering with a late hour agreement to save the day is becoming a tiring act. Markets do not enjoy it, and consumers do not enjoy it. It is obvious that debt ceiling fights have been about power, largely built around controlling the budget and spending initiatives. Taxes are an important point but raising taxes is becoming a challenge for both parties thus debt spending becomes the focus.
Conservative-leaning legislators believe tax cuts incentivize work and entrepreneurship with the resulting economic growth boosting tax collection to repay the debt. Liberal-leaning legislators believe economic growth will likely cover those debt costs without a need to provide debt-financed tax cuts to boost growth. Both sides would likely make some good points in an open and honest discussion.
An effective government negotiates a budget that delivers a compromised solution that appropriately uses debt and tax revenue to achieve long-term investments and solutions for the economy. Yes…this is easier said than done.
At the current moment, Congress notoriously struggles to pass spending bills on time with the political brinkmanship consuming the discussion. Then there is a debt ceiling dance that observers have to pretend will solve the budget issues.
Some members of Congress are currently arguing that the spending cuts in the debt ceiling agreement undercut military efforts, especially with Ukraine, and should be increased with new legislation separate from the debt ceiling agreement. These members may be right, but again the issue is with properly creating a budget that accounts for all spending initiatives alongside actual revenue collection.
Economics can be complicated, thus the government hires and pays economists. However, budgeting is hopefully something all people have some experience with. Compromising with others…well, let’s assume this is a skill honed through many years of schooling alongside daily interactions with people at home, at work, and in public.
Articles represent the opinions of their writers, not necessarily those of the University of Chicago, the Booth School of Business, or its faculty.
