The US Debt Ceiling Deal: A Miss Opportunity for Fiscal Reform?

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The debt ceiling sets a cap on the overall amount of borrowing by the government. It was initially established by Congress during World War I with the intention of providing broad authorization for the Treasury Department to borrow money up to a specific sum. 

Before 1917, each Treasury Bond had to be approved by Congress, which was time-consuming and ineffective. The debt ceiling, commonly referred to as the debt limit or statutory debt ceiling, was established by the Second Liberty Bond Act of 1917.

Because it impacts the government's capacity to borrow money and spend it, the debt ceiling has an impact on the federal budget as well as the economy. When the government exceeds its borrowing limit, the debt ceiling must be lifted or else it risks not being able to meet its responsibilities, including paying interest on the debt, disbursing Social Security checks, and funding military activities. The financial markets in the US and around the world, as well as the stability and growth of the national economy, could suffer significantly as a result.

Since 1960, there have been 78 increases, extensions, or revisions to the debt ceiling under both Democratic and Republican administrations. As the United States engaged in more conflicts abroad, passed tax cuts, handled emergencies, and increased federal expenditures, it accrued greater debt. The debt ceiling's conception and history go back to the US involvement in the First World War in the middle of the 20th century. In the early years of the American Republic, Congress used to authorize and issue bonds. In 1898, for instance, the Treasury issued both long- and short-term debt bonds in connection with the American-Spanish War.

Recent years have seen an upsurge in the political dispute over the debt ceiling as certain lawmakers have threatened to veto an increase unless specific demands for policy are met. As a result, there is uncertainty and risk for the US economy and financial system. If the debt ceiling is not raised, there may be a first-ever default on American debt.

Congress approved a short-term agreement in October 2021 to raise the debt ceiling through December 3, 2021, preventing a possible default and providing politicians more time to discuss a longer-term solution. Yet, because this agreement did not address the underlying reasons for the escalating debt and deficits, it represented a squandered chance for fiscal reform.

Due to higher costs for entitlement programs, defense, and pandemic relief as well as lower tax collections from tax cuts and economic downturns, the US debt has dramatically expanded in recent years. By 2051, the debt is expected to be 202% of GDP, according to the Congressional Budget Office, which could seriously jeopardize the US's capacity to maintain fiscal stability and perform economically.

The White House and Congress engaged in lengthy discussions to negotiate the most recent debt ceiling agreement in May 2023, when the US government was at risk of defaulting on its debts. The agreement aimed to prevent a fiscal crisis and give markets and the general public some assurance.

The deal included the following key provisions:

• The debt ceiling was raised by $2.5 trillion, which will be sufficient to meet the government's borrowing requirements through September 2024.
• Additionally, the agreement called for $1.2 trillion in spending reductions over a ten-year period, split equally between defense and non-defense agencies. Unless Congress came to a different agreement before December 2023, the cuts would be enacted automatically through sequestration.
• The agreement also included $600 billion in revenue-generating measures, most of which came from eliminating tax loopholes and reducing deductions for high-income taxpayers over a ten-year period. A fast-track procedure would be used to pass the revenue proposals, which only needed a simple majority in both chambers of Congress to pass.
• Plans for a possible default were also mentioned in the agreement. The Treasury Department would pay bondholders, Social Security recipients, and active-duty military people first if it ran out of money to cover its expenses. The agreement also gave the president the power to raise the debt ceiling on his own initiative in the event that Congress did nothing.

Analysis

Some praised the agreement as a bipartisan compromise that prevented a disastrous default and decreased the debt. Some, on the other hand, condemned the agreement as being insufficient to address the US's long-term budgetary problems or as being unfair to specific people or industries that would be hardest hit by the expenditure cuts or tax hikes.

The pros

One of the key advantages of the agreement is that it averts a government default on its debt commitments, which may have brought on a global financial crisis and hurt the nation's credit rating. The agreement averts a worst-case situation that would have hurt millions of Americans and companies by extending the debt ceiling and guaranteeing that the government can pay its payments.

Another advantage of the deal is that it reduces the projected deficit by about $2.1 trillion over the next decade, according to the Congressional Budget Office. To accomplish this, discretionary expenditure limitations are put in place, and a bipartisan committee is established to find other ways to save money. Additionally, if the committee is unable to come to an agreement, the agreement has a provision to automatically implement across-the-board budget reductions.

The fact that the agreement leaves some financial room for future requirements like infrastructure, education, health care, and social security is a third advantage of the agreement. The agreement allows the government more flexibility to invest in long-term priorities and respond to unforeseen problems by reducing the debt-to-GDP ratio and stabilizing the budget outlook. The agreement also leaves some room for revenue increases and tax reform, which might support economic development and lessen inequality.

The cons

The arrangement contains significant flaws that might harm the economy's long-term prospects even though it may appear appealing in the short run. One of the fundamental problems with the agreement is that it delays structural changes that are necessary to increase growth, productivity, and competitiveness. Structural reforms are actions that alter the institutional and regulatory framework within which people and corporations conduct their operations, as well as the structure of an economy.

These may consist of measures to boost the business climate, encourage innovation, increase labor market adaptability, lessen tax evasion and corruption, and encourage social justice and inclusion. The arrangement misses an opportunity to address the underlying causes of the economic issues and to build a more robust and dynamic economy by postponing these reforms.

The deal's reliance on irrational assumptions about the economy's future performance is another drawback. The agreement makes the assumption that the economy would recover rapidly from the crisis and that growth will be maintained at a high level for several years. This scenario, nevertheless, is excessively rosy and ignores the dangers and ambiguities that can jeopardize economic recovery.

For instance, the deal does not take into account the likelihood of outside shocks, such as a new pandemic wave, a global economic downturn, or a geopolitical confrontation. It also doesn't take into consideration any possible destructive feedback loops between monetary, fiscal, and financial stability. The agreement also disregards the economy's underlying flaws, like sluggish productivity growth, high unemployment, aging populations, and rising inequality. These elements can restrict the economy's potential output and demand, making it more difficult to meet the budgetary goals established by the agreement.

Last but not least, the deal ignores the long-term difficulties the economy faces in a changing world. The requirement for adaptation to social changes, the green transition, and the digital transformation that are altering the economy and society is not covered by the agreement. These issues call for an all-encompassing strategy that goes beyond band-aid solutions and stopgap remedies. 

The deal makes insufficient investments in public goods, infrastructure, research and development, human resources, and other areas necessary for boosting innovation and competitiveness in a knowledge-based economy. The deal also ignores social and environmental problems including poverty, social exclusion, pollution, climate change, and others that have an impact on people's quality of life and well-being. Hence, the agreement falls short of guaranteeing the economy's sustainability and inclusion.

Conclusion

In conclusion, the recent debt ceiling deal had conflicting effects on the US economy's recovery and budgetary prospects. On the one hand, it prevented a potentially disastrous default on US debt repayments and reduced some of the uncertainty that hampered market mood. On the other hand, it placed some expenditure limitations that would limit public investment and social welfare while failing to address the root causes of the fiscal imbalance.

The deal also delayed any significant change of the budgetary process until 2025, delaying the issue's impact on the upcoming presidential election. The deal also deferred the debt ceiling until that year. The agreement was therefore not adequate to secure long-term budgetary sustainability and economic progress, even though it was an essential step to prevent a crisis.

Recommendations

The US debt crisis is a significant issue that jeopardizes the nation's security and future development. The federal government has been borrowing at historically high rates and consistently spending more than it brings in. As a result, there is a significant federal debt that is outpacing the size of the economy. The public's debt as of 2018 was 78% of GDP, and by 2048, the Congressional Budget Office (CBO) predicts that it will be 150% of GDP. This is a risky level that might have unfavorable effects on both the US and the rest of the world.

Some of the main causes of the US debt problem are:

• Recessions: Tax revenues are decreased and spending on social programs like food stamps and unemployment benefits is increased during economic downturns. The Great Recession of 2007–2009 and the COVID-19 pandemic of 2020–2021 both resulted in significant deficits and increased debt.
• Defense budget growth: The US spends more than any other nation on defense, with nearly 15% of all federal spending in 2018 going to the military. The growth in defense spending over time has been influenced by both the Iraq and Afghanistan conflicts as well as other security concerns.
• Tax cuts: In recent decades, the US has lowered its tax rates numerous times, most notably under Presidents George W. Bush and Donald Trump. These tax cuts narrowed the gap between government expenditure and revenue while simultaneously reducing the government's income, which was intended to spur economic growth and increase revenues.

To address the US debt problem, some policy actions that could be considered are:

• Reforming entitlement programs: Social Security, Medicare, and Medicaid are the main sources of federal spending, accounting for nearly 50% of total spending in 2018. As the population ages and healthcare expenditures rise, these programs are anticipated to expand more quickly than revenues. Raising the eligibility age, cutting benefits, boosting payroll taxes, or adding additional means of testing are all potential reforms for these programs.
• Reducing discretionary spending: Discretionary spending refers to the portion of the federal budget that is subject to annual appropriations by Congress. It covers a variety of fields, such as transportation, education, and research. Setting limits or targets, giving priority to important initiatives, getting rid of waste and redundancy, or outsourcing some tasks to the private sector are all possible ways to cut back on discretionary spending.
• Increasing revenues: Raising tax rates, expanding the tax base, eliminating deductions and loopholes, or enacting new taxes like a carbon tax or value-added tax are all potential ways to raise more money for the government. Raising revenue may also entail encouraging economic expansion through trade, immigration, infrastructure investment, or innovation.

Although the US debt issue is not insurmountable, it does require political will and public awareness in order to be effectively addressed. Unchecked, it can result in higher interest rates, slower economic expansion, fewer fiscal flexibility, and more proneness to external shocks. In the long run, the US will be better off if it reduces its debt sooner rather than later.