Wednesday, May 11, 2011

Should We Raise the Debt Ceiling?

Washington is still engulfed in an intense debate about whether to raise the federal debt ceiling. In the end, I predict the debt ceiling will be raised in return for some sort of spending cuts, or at least a commitment to cut spending in the future.

The responsible choice is to raise the debt ceiling. Not doing so carries with it the risk of defaulting. In that case, it would be hard to convince people to invest in treasuries for the foreseeable future. If an outright default does not happen, investors would still view the US political system as increasingly dysfunctional and demand higher interest rates, meaning that our debt would grow. This leaves us with two unappealing choices. Taxes could rise which make most people unhappy and decrease the amount of money available for consumer spending and investment at a critical time for the economy. The second option is that our budgets would slowly choke off money for anything besides defense and core entitlements such as Medicare and Social Security. Investments in education, job training, and a safety net for the poor among others would all be hurt.

It is possible to imagine how conservatives might like how either of these scenarios plays out. By preventing the government from borrowing more money if they force default, conservatives would require people to pay higher taxes to finance the level of government spending we have now. They may well bet that when faced with a choice between higher taxes and lower levels of government spending, citizens will choose the latter.

But this does not take into account the short term political fallout that could accrue to Republicans in the event of a government shutdown. Republicans have traditionally opposed government programs more than Democrats. The loudest voices on the right want a dramatic reduction in the federal government’s role in the lives of Americans. Even more mainstream ones such as Paul Ryan want to substantially restructure entitlements like Medicare by making what amount to cuts. It will be easy for Democrats to say they were willing to make compromises, but that Republicans were so bent on gutting Medicare and Social Security that they were willing to let the country default on its debts.

Politically, President Obama stands in a decent position to win. What he needs now is a credible plan to reduce the deficit long term that avoids some of the cuts that the Ryan plan or other conservative variants have. Republicans will then have to acquiesce to his budget in which case they share in any of the political pain, or they can allow the country to default and walk away from a reasonable proposal and be tagged as radicals for a generation for wanting to make changes in popular entitlement programs that the majority of voters will not support.

In this game of chicken between the two parties, the stakes could not be higher. If reasonable choices are not made, America will be the loser.

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