The Debt Limit Debate
By David Henderson
On January 6, 2011, Treasury Secretary Tim Geithner sent a letter to Harry Reid in which he stated:
Failure to raise the [debt] limit would precipitate a default by the United States.
In context, it’s clear that by “the United States,” Geithner really means “the United States government.”
But would it necessarily trigger a default? Newly elected U.S. Senator Pat Toomey wrote a January 19 Wall Street Journal op/ed in which he pointed out that the amount of money required to continue to make payments on all the U.S. government debt is a small fraction of the amount of revenue the U.S. government raises. Toomey wrote:
Next year, for instance, about 6.5% of all projected federal government expenditures will go to interest on our debt, and tax revenue is projected to cover about 67% of all government expenditures. With roughly 10 times more income than needed to honor our debt obligations, why would we ever default?
Treasury official Neal Wolin responded to the Toomey idea of prioritizing payments on the national debt as follows:
While well-intentioned, this idea is unworkable. It would not actually prevent default, since it would seek to protect only principal and interest payments, and not other legal obligations of the U.S., from non-payment. Adopting a policy that payments to investors should take precedence over other U.S. legal obligations would merely be default by another name, since the world would recognize it as a failure by the U.S. to stand behind its commitments.
Wait a minute. If you succeed in making principal and interest payments, don’t you avoid default? Wolin is equivocating on the term “legal obligations.” As I understand the term “obligation,” the government is not obligated to pay for goods and services when it doesn’t get those goods and services. So the government could cut the goods and services it buys without violating any obligations.
Toomey wrote a letter to Geithner on February 2 taking on Wolin’s sloppy reasoning. Geithner replied on February 3 and gave an analogy. Geithner wrote:
A homeowner could decide to “prioritize” and continue paying monthly mortgage payments, while opting to cease paying other obligations, such as car payments, insurance premiums, student loan and credit card payments, utilities, and so forth. Although the mortgage would be paid, the damage to the homeowner’s creditworthiness would be severe.
(I couldn’t find the whole letter on the web; I got it from Senator Toomey’s office.)
Again, wait a minute. Notice Geithner’s mixing of debt obligations and other expenditures. On car payments and student loan and credit card payments, Geithner is right. But on insurance premiums and utility payments, he’s wrong. Those are not typically debt obligations. Geithner is effectively saying that if the government wants to spend x and has only enough money to spend 0.67x, then not spending on the other 0.33x is a failure to keep an obligation. In a political sense, that might be: the government has made a lot of spending promises to a lot of people. But in an economic sense, it’s not. On the narrow issue of whether failure to raise the debt limit would necessarily mean U.S. government default on its debt, Toomey is right and Geithner is wrong.