The Looming Budget Train Wreck
Policy + Politics

The Looming Budget Train Wreck

Nick Bhardwaj / The Fiscal Times

Many economists believe that the great recession resulted from a “perfect storm” of various factors that were not too serious individually, but when combined they interacted in ways that created a crisis that was larger than the sum of the contributing causes. Something similar is developing with the federal budget. We are facing a confluence of factors that would be manageable in isolation, but will be extraordinarily difficult to deal with simultaneously.

The first problem is that Republicans reclaimed the House of Representatives having made promises that are impossible to keep. House Republicans often talk as if they control the entire government, rather than just half of one branch. In our system of government, that really only confers veto power and a modest ability to set the agenda. Without also having the presidency and a filibuster-proof majority in the Senate, control of the House isn’t worth very much in terms of actually changing the law.

Insiders and anyone even slightly familiar with how the federal government operates knows this. Unfortunately, many members of the Tea Party movement seem not to have taken civics in high school and insist that Republicans push forward on utterly futile efforts, such as repealing the Affordable Care Act. For starters, this will never pass the Senate; and even if a majority supported it, Democrats would simply use the same filibustering tactics that Republicans have perfected to block passage. If by some miracle, 60 votes could be found to break a filibuster, President Obama would certainly veto it. To override, Republicans would need a two-thirds majority in both the House and Senate, something that is unlikely in the extreme.

The symbolic vote to repeal health reform in the House is no big deal; it was just a waste of time. A more serious problem is a foolish promise Republicans made during the campaign to cut $100 billion out of the current fiscal year’s budget. The reason it was foolish is that the fiscal year begins on September 1. Thus we were one-third of the way through the fiscal year the day Republicans took control of the House. By the end of next week, we will be 40 percent through the fiscal year.

Leaving aside the problems of the Senate and a possible veto, there is a very serious technical problem with cutting spending in this fiscal year when we are already midway through it. For one thing, Republicans would need to actually cut $200 billion on an annual basis if the cuts are enacted by the end of next month. The longer the cuts are delayed, the larger they will have to be to achieve the goal of cutting $100 billion this year.

An even bigger problem is that it’s far more difficult to find fast-acting spending cuts of that magnitude than Tea Party people routinely assert. They seem to think that the budget consists of spending that Congress has to appropriate yearly. In fact, only a minority of the budget falls into this category.

Using fiscal year 2009 numbers for illustration, 65 percent of the budget was for mandatory programs that require no appropriation, such as Social Security and Medicare, as well as interest on the debt. The remaining part, which is called discretionary spending, is the only part that is controlled by the appropriations process. Of this, 53 percent went to national defense, which Republicans are unlikely to cut. All the rest came to less than $600 billion or about 16 percent of total spending in 2009.

Now suppose Republicans wanted to cut $100 billion from the budget midway through fiscal year 2009. As noted earlier, they would have had to cut $200 billion to actually achieve that goal. Since it’s virtually impossible to cut mandatory spending quickly and since Republicans won’t cut defense, that means the $200 billion in cuts would be limited to domestic and international programs. But since we would be halfway through the fiscal year at this point, $300 billion of the $600 billion spending in this budget category has already been spent. This means that the $200 billion in spending cuts would have had to be made from an available budget of just $300 billion, which effectively would mean abolishing just about every government function outside of entitlements, interest, and defense.

However much the Tea Party may wish for such an outcome, that’s not going to happen. And every budget expert in Washington knew it when Republicans made their $100 billion spending cut pledge back in September. However, only those not affiliated with the Republican Party pointed this out; those working for right wing think tanks kept their mouths shut lest it diminish Republican electoral chances.

Nevertheless, Republicans still plan massive spending cuts this year. They have two vehicles for doing so that will both require action at about the same time. The first is completing the basic appropriations for this year. This should have been completed before the beginning of the fiscal year last September 1, but because of Republican delays it didn’t get done. The government is now operating on what is called a continuing resolution that expires on March 4.

Unless another continuing resolution is enacted into law before March 4 we will have a classic government shutdown such as happened back in 1995. This results because of an 1870 law called the Antideficiency Act. In the absence of a congressional appropriation, most government employees are sent home and most government operations are shut down. (For details, see this report from the Congressional Research Service, and this memorandum from the Justice Department.) One exception is the Defense Department, which is largely exempt from a shutdown because of the Feed and Forage Act of 1861.

At about the same time that the current budget resolution expires, the Treasury Department estimates that it will hit the limit on the national debt. Once the limit is reached, the Treasury may not borrow any additional money. It would therefore be limited to paying bills only out of the cash flow that comes in from tax withholding, which is not regular but mainly comes in January, April, June, September and December, when businesses and individuals file returns and make estimated tax payments.

Many Tea Party members and uninformed Republicans foolishly think that the debt limit is a meaningful constraint on national indebtedness. In fact, it is superfluous because the actions that created the debt – spending and tax cuts – have already been taken. The deficit is simply the inevitable consequence and refusing to accept it by not raising the debt limit is nothing but irresponsible grandstanding.

But the grandstanding is not costless. Without cash, the Treasury can’t pay its bills, including interest on the debt, Social Security benefits or anything else. Thus the effect would be similar to a failure to appropriate spending, but far more extensive because it would impact entitlement programs and interest payments that could still be made in the absence of appropriations legislation.

The biggest problems will occur with Social Security and interest payments. Some people claim that Social Security benefits can be paid as long as there are sufficient assets in the Social Security trust fund to cover benefit payments. The trust fund would simply liquidate some of the Treasury bonds it holds to raise cash. But if the Treasury has no cash to redeem the bonds it can’t pay benefits. The bonds can’t be sold to investors because they are not marketable and the Federal Reserve can’t buy them because it is prohibited by law from buying bonds directly from the Treasury. Therefore, Social Security benefits cannot be paid in the event that the Treasury runs out of cash due to a failure to lift the debt limit.

Some people on Wall Street apparently think that the Treasury will always have sufficient cash flow to pay interest on the debt. However, it’s very unclear as to whether it has the authority to prioritize spending in order to ensure that it has the cash to pay interest on the day it is due. In my opinion, failure to raise the debt limit in a timely manner would very likely lead to default, which would roil financial markets and likely increase the cost of Treasury borrowing for many years to come due to an increase in risk.

Wise Republicans understand that default is not an option. But many of their colleagues have said repeatedly that they will not vote for a debt limit increase under any circumstances. And those that would are scared to death of a Tea Party challenger in the Republican primary who accuses them of increasing the debt. These Republicans know that many Tea Party people don’t care about the consequences of their actions and would rather lose a seat to the Democrats, as happened in the Colorado, Delaware and Nevada Senate races last year, than support a Republican who violated what they deem to be fundamental conservative principles by voting for a debt limit increase.

The wiser Republicans are hoping to craft some sort of budget-cutting package that can be attached to the debt limit in order to give them cover in voting for a debt limit increase. But it’s not clear that this helps politically. A January 12 Ipsos/Reuters poll found that 71 percent of Americans oppose raising the debt limit even when told that it would destroy the nation’s credit rating and raise interest rates. The same poll also showed that a majority of Americans oppose cutting any program except foreign aid and the budgets of the Internal Revenue Service and Securities and Exchange Commission – very trivial cuts in a $3.5 trillion budget.

The real problem for Republicans is time. It takes a lot of it to draft, debate and pass budget cutting legislation – just ask anyone who participated in the various budget deals enacted between 1982 and 1993. And House Republicans have yet to figure out how they will deal with the White House or a Democratic Senate in implementing all their big promises. But the Tea Party people may not allow them to back down no matter how severe the consequences in terms of a government shutdown, suspension of Social Security payments, and default on the debt. That’s the recipe for a budgetary train wreck.

Related Links
One Man’s Debt Ceiling is Another Man’s Floor (The Fiscal Times)
Some Experts Are Bracing for a Default on U.S. Debt (The Fiscal Times)
Senate Democrats Seek Trillion Dollar Debt Limit Hike (The Fiscal Times)