Update 558 — Debt Limit Dilemma:
Have Faith in “Full Faith and Credit”?
The U.S. financial system and therefore the economy is under the sword of Damocles right now, with the statutory debt limit already exceeded, emergency measures estimated to expire as soon as mid-October, markets in turmoil, and no viable legislative solution in reasonable reach.
Last night, the House passed a debt limit suspension through December 2022, which was attached to the continuing resolution (CR) Congress must pass this month to avoid a government shutdown — a strategy that runs serious risks, as Senate Republicans have vowed to vote against any debt limit legislation. A brinkmanship approach may be costly beyond measure.
In this update, we examine what Democrats’ main objectives should be for debt limit strategy and what can and cannot be done to accomplish them.
Key Objectives Moving Forward
With House passage of a debt limit suspension, attention now turns to the Senate. Most Senate Republicans have vowed to vote against any debt limit legislation, and Democrats, in turn, have not backed down from their primary strategy, raising the stakes of a dangerous game of chicken. In the days ahead, Democrats will need to keep the following objectives in mind:
- Minimize macroeconomic consequences. One of the most consequential effects of the 2011 debt limit crisis, even though a default was avoided, was the United States having its credit rating downgraded. Uncertainty regarding debt limit negotiations could result in financial market turmoil or another credit downgrade. This could have severe economic ramifications in the form of higher borrowing costs or even a recession. The GAO estimates that the 2011 crisis resulted in $1.3 billion in higher borrowing costs for the Treasury Department.
The potential consequences are not binary: Even if a default is avoided, market turmoil or a credit downgrade could still have real and negative effects, both in terms of damage to the U.S.’s political credibility as well as hits to everyday people’s pocketbooks. Per Moody’s Analytics, economic uncertainty caused by the debt limit fights of the Obama era meaningfully reduced the post-2008 recovery. This week, financial markets are beginning to show unease over the debt limit standoff. Democrats will almost certainly bear the brunt of the blame for any negative economic effects and could pay a significant political price in the 2022 midterms.
- Minimize political exposure. Debt limit votes tend to be politically painful, particularly for moderate members, because of a widespread misunderstanding of the difference between public debt and household or business debt. Democrats’ current strategy of seeking a bipartisan vote is an effort to share responsibility, thereby avoiding Democrats “owning” a debt limit increase on their own. But the longer the issue remains in play, the more costly political exposure Democrats will have to endure. Democrats would be most disadvantaged by an outcome resulting in multiple votes or extended negotiations.
- Avoid any policy concessions. In the past, Congressional Republicans have sought to use the debt limit as a bargaining chip to force Democrats into policy concessions. Republicans extracted the Budget Control Act from their hardline position during the 2011 debt limit crisis. This law established harmful caps on federal spending and likely curtailed the post-2008 economic recovery — a very high price to pay for negotiating. In recent months, some Republican Senators have floated calls for spending cuts or entitlement reform in exchange for supporting a debt limit increase. One potential risk of tying the debt limit to the CR is a deal in which Republicans vote yes in exchange for budget cuts. This would be a highly undesirable and unnecessary outcome. Fortunately, the White House has reportedly ruled this out.
Risks of the Current Strategy
Democrats’ current strategy assumes that Republicans will cave when the time comes. After all, Republicans voted to suspend the debt limit three times under the Trump administration. However, there is no reason to believe Republicans would do the same under President Biden. Republicans have demonstrated repeatedly they are not keen to lift a finger to help Democrats avoid a crisis.
Congress first instituted the debt limit in 1917 to allow the Treasury to issue debt without Congressional approval for every issue. Since then, Congress has raised or temporarily suspended the limit several dozen times, mostly on a bipartisan basis. But Republicans’ hostile stance has called this tradition into question.
Minority Leader McConnell is not bluffing when he says Republicans will not vote for a debt limit increase or suspension. His goal is to make this as painful as possible for Democrats. Republicans may even feel incentivized to let a default occur since the resulting economic damage would likely be blamed primarily on President Biden and the Democrats. They appear to happily push the narrative that Democrats’ out-of-control spending led to the default and capitalize on the chaos.
Sen. Rick Scott is already anticipating Treasury bonds to decrease in value amid the standoff. His advice to not invest in Treasury bonds (“If you’re foolish enough right now to be buying this stuff, you’re foolish.”) displays the immense cynicism Republicans are employing. Unfortunately, Republicans stand to gain politically from an economic catastrophe and cannot be relied on to act responsibly.
Road to Reconciliation Open but Steep
McConnell’s intransigence is infuriating and hypocritical, but it cannot be wished or willed away. For this reason, Democrats should not close the door to the one backup plan that does not require Republican votes. The debt limit can be raised via budget reconciliation, which would require only a majority vote in the Senate.
In order to do this, Democrats would have to cross some procedural hurdles since debt limit instructions were not included in the FY2022 budget resolution:
- First, Congress would need to revise the budget resolution, which would require majority votes in both chambers and possibly two vote-a-ramas in the Senate. But time may be running short to do so.
- After that, Democrats would need to decide how much to raise the debt limit or try to suspend it. While reconciliation has only ever been used to raise the limit, the Parliamentarian has never ruled whether it can be used for suspension, and no precedent exists, leaving the (albeit unlikely) possibility open.
- Finally, a debt limit reconciliation bill can be passed as a standalone measure; it does not need to be included in the Build Back Better reconciliation passage.
Brinks Can Be Closer Than They Appear
Through a convoluted process, reconciliation may be the best legislative option available to avoid GOP fiscal or policy hostage-taking again. So far, leadership has kept this off the table out of concerns that specifying a dollar increase would be politically painful and that passing a debt increase with only Democratic votes would let Republicans “off the hook” by skirting legislation that has always been bipartisan. It is for both of these reasons, in fact, that Republicans want Democrats to use reconciliation.
Minority Leader McConnell asserts that Democrats have the responsibility to raise the limit alone since, in control of Congress, they can alone. A novel principle at odds with his own actions in the recent past. But brinkmanship comes at a cost, a cost that is assessed before the unknowable but fast-approaching X date. The losers so far are just capital markets participants but the real economy would not be far behind in the event of default. Democrats will receive most of the blame if things go wrong. The risks of negative economic consequences, even if a default is avoided, cannot be ignored. Avoiding such consequences must take priority over any political concerns. Democrats can bite the bullet now and take the responsible action — and then remind voters afterward which side was willing to tank the economy.