America’s debt ceiling crisis

Negotiations in Washington are providing an instructive lesson in political economy as both parties haggle over terms for raising the debt ceiling (currently at $14.3 trillion, to be hit on 2nd August). Republicans, employing Rahn curve analysis, argue that optimum government spending (as a percentage of GDP), is around 18%. Yet this level has been far exceeded - hence the cry from the right that the deficit problem is not because Americans are taxed too little, but rather because their government is spending too much.

There are fears about what happens if an agreement is not reached. At the extreme end of ‘Tea Party’ complacency, it is argued that the United States will not default, as there is enough monthly revenue to pay for essential non-discretionary obligations such as interest payments on its debts, military payrolls, and social security entitlements - some 60% of federal expenditures. It is the other 40% that causes concern, and even the most fervent Republican deficit hawks believe that the debt ceiling must be raised, if only to carve out the necessary space to plan further cuts free from national hysteria.

Nevertheless, the prospects of an amicable agreement are bleak, requiring great reserves of chutzpah for anyone who will hazard an opinion on the eventual outcome. The ‘government as saviour’ mentality is so ingrained into the plurality forming the recipient class that gains for liberty will be few and form pyrrhic victories, crippling further reforms.

If the Obama Administration succeeds in browbeating Republicans into bowing to pressure for tax rises - additional revenue not met by closing special interest loopholes - the long-term implications are stark, as explained by pollster Dick Morris:

‘It is terribly important that we reduce the size of our government. We can’t have the government eating up 44 per cent of our Gross Domestic Product like it is to-day ... and still have a free enterprise system. You just can’t have the government absorbing that much capital and still have a country with a free market system left. So the issue is not just to balance the budget. Not just to roll back federal spending. Not just to help the economy by not taxing people. But to go further and to limit the size of government so that you can have enough capital for a free market system. You can’t have capitalism without capital and if the government’s eating up all of the capital you can’t begin to have it.’

One point that most discussions of the situation miss is that a debt limit does not affect Social Security expenditures. The reason is that the Social Security Trust Fund, money the federal government borrowed and spent from Social Security revenue and now owes to the Social Security Administration, is included in the national debt. If SSA needs money to pay out social security checks, it goes to the treasury, cashes (say) $20 billion of the bonds that are the assets of the trust fund, sends out the checks. The trust fund is now $20 billion lower, which means the national debt is now $20 billion below the debt limit, so the Treasury can borrow an additional $20 billion and spend it on whatever it had planned to spend the first $20 billion on. That process can continue until the trust fund runs out of money. Since it is currently over two trillion dollars, that is likely to take a while. For details, see:
Who is so rich that they can lend the United States $14.3 trillion?
The negative impact of tax rises beyond the ‘optimum’ of the Rahn curve has been brilliantly summarised by Harvard economist Jeffrey A. Miron: ‘By reducing the income of households and the profits of businesses, higher tax rates discourage consumption and investment, slowing the economy in the short run. By reducing hiring, savings, and investment, they reduce economic growth in the long run. And higher tax rates are undermined by tax evasion and avoidance, making them an inefficient way to raise revenues.’
@Michael Patek China.

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