Debt-Limit Debate: Myth vs. Reality

October 11, 2013

As federal government borrowing is set to exceed yet another debt limit, most are quick to recall the 2011 debt-limit showdown. If current rhetoric is any indication, it appears many of the last debate's lessons -- and facts -- have been forgotten, say Jason Fichtner and Veronique de Rugy, senior research fellows at the Mercatus Center at George Mason University.

Fichtner and de Rugy explore some of the myths surrounding the debate.

Myth #1: Standard and Poor's (S&P) U.S. credit rating downgrade in August 2011 was caused by Washington's brinkmanship over increasing the debt limit. Congress must therefore avoid attaching spending-cut demands to the current debt-limit increase if they want to avoid jeopardizing the nation's fragile economy.

  • Reality: Washington's failure to deal with unsustainable federal spending mostly related to entitlement programs and debt caused the 2011 S&P downgrade and is spurring warnings of another downgrade by the credit rating agencies.

Myth #2: Had Congress and the administration failed to raise the debt limit by the Treasury's stated deadline in 2011, the Treasury would have been forced to default on the nation's debt.

  • Reality: Had the 2011 agreement to increase the debt limit been postponed, the Treasury could have met federal government obligations -- including Social Security benefits and interest on the debt -- until the end of the fiscal year, possibly longer.

Myth #3: If Washington agreed to significant spending reforms and cuts -- and then actually followed through on them -- it would cripple the recovery and devastate the economy.

  • Reality: The most dangerous thing Washington can do is continue on its current course. Washington must agree on meaningful spending reforms and begin implementing these policies immediately to satisfy markets about the credibility of spending cuts.

Myth #4: The real problem with the last debt-limit deal was that it failed to apply a "balanced approach" of spending cuts and tax increases.

  • Reality: Replacing borrowing with higher taxes does not solve the fundamental problem: federal spending -- including Social Security, Medicaid and especially Medicare -- is unsustainable.

Myth #5: Interest rates on public debt declined in the wake of the 2011 downgrade. This suggests that the United States can retain its global creditworthiness, regardless of its credit ratings or debt levels.

  • Reality: Interest rates are artificially low today because the Federal Reserve is keeping rates low in hopes of boosting the economy and because other countries are in even worse fiscal shape than the United States. This is not sustainable long term. If Washington does not act to significantly improve the federal government's fiscal outlook, its creditors will demand higher interest rates, and the already unsustainable budget and economic situation will worsen.

Source: Veronique de Rugy and Jason J. Fichtner, "The Debt-Limit Debate 2013: Addressing Key Myths," Mercatus Center, October 10, 2013.

 

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