Needless to say, the US has a long-term debt problem.  The problem is long-term both in the sense that it pertains to the next several decades rather than to this year.  (Indeed, the deficit/GDP ratio has been falling since 2009, despite the weakness of the economy.)   The problem is also long-term in the sense that we have known about it for a long time; it was clear in 1991 and should still have been clear in 2001.
     It should be almost as needless-to-say that the approaching debt ceiling bomb is not helpful in solving our fiscal situation, any more so than were previous standoffs:  the January 1, 2013, fiscal cliff; before that, the August 2011 debt ceiling standoff, which led Standard and Poor’s to downgrade the credit rating of US debt for the first time in history; and before that, the 1995 shutdown of the government, which largely discredited Republican House Speaker Newt Gingrich.  
     The current debt ceiling bomb is, of course, another attempt to hold the country hostage under threat of blowing us all up.  The conflict is usually phrased as a question of ideological polarization, a battle between fiscal conservatives and their opponents.  This familiar frame does not seem right to me.  There is in fact no correlation or consistency between the practice of federal fiscal discipline and the political rhetoric, either across states or across time.

          What are the demands of the hostage-takers?   Even if there existed an explicit ransom letter detailing specific severe spending cuts, in exchange for which it credibly offered to raise the debt ceiling, President Obama’s refusal to negotiate under such conditions would be fully justified.  But the situation is worse than that.  There is no specific set of demands, and never has been.  I truly believe there does not exist any set of spending cuts that the blackmailers would accept if they came from Obama. 
     Remember the occasions in the past when he has announced that he will accept the Republican position on some issue, only to have his opponents switch places, saying “if you are in favor of it, we are against it”?    One example was the idea of Obamacare itself, which originally came from conservative think tanks and Mitt Romney.   Another example was the proposal for an automatic version of what in February 2010 became the Simpson-Bowles Commission.
     There are only so many dollars that can be cut out of PBS and foreign aid.   If, hypothetically, Obama were to come out in support of severe cuts in agricultural supports, oil and gas subsidies, Medicare benefits and other programs, Republicans would attack him for proposing hurtful cuts. (Remember attacks on Obama’s health plan for non-existent “death panels” and fictional cuts to Medicare benefits?)  Simultaneously, Republicans would say that the cuts were not big enough. 
     What would be enough?   Some debt crazies have said they think it would be fine if we failed to raise the debt ceiling.  Some are crazy enough to think it is not a problem if the US government were to default on its legal obligations.  (They may not realize that defaulting on the bill for office supplies that you ordered from Staples is as bad as  missing interest payments on your debt.)  But some want to enforce a balanced budget immediately:  the refusal to allow the government to borrow any more is not just a negotiating tactic, but is the outcome they want.  This is crazy in light of the adverse economic and financial impact (which would be much worse than that of the fiscal cliff that we just dodged two weeks ago).    
     But the prize for ultimate insanity must go to those who want to eliminate the budget deficit rapidly and insist on doing it without raising taxes, cutting defense, or cutting programs for seniors.  These people deserve the label “deranged” because what they are demanding is for a literally false proposition to be true.  It is arithmetically impossible to eliminate the budget deficit if the cuts are to come primarily in non-defense discretionary spending.  
     To be very clear, I don’t think most Republicans believe all of this.  Certainly my many economist friends who are Republicans do not.  The truly “deranged” people are just a subset of the “crazy” people, who are in turn a subset of those who are unwise enough to favor the debt ceiling threat as a tactic, who are in turn a subset of the Republican Party.   The problem is that it is this minority of a minority that is holding the whole country hostage.  The size of the minority evidently shrunk after the August 2011 debt ceiling debacle, after the November 2012 election, and after the January 1 cliff.   But it still has its finger on the grenade pin.

          So that leads us to the question of tactics.  A variety of stratagems have been proposed for the White House to use to defuse the bomb, if it comes to that.  These are all designed as ways that the federal government can continue to meet its legal obligations beyond March, even if the Congress doesn’t raise the debt ceiling.   While these unconventional proposals are beyond anything that would have been contemplated under normal conditions, they must be considered, in light of the correspondingly absurd situation in which the country would find itself.  If the Congress refuses to act, the White House would have to choose between two contradictory laws: the one that Congress passed to authorize spending and taxes versus the debt ceiling law that apparently prohibits the government from borrowing to make up the difference between spending and taxes.  Following the implication of the latter law would have disastrous impacts on the country and the world if obeyed.

• Given the contradiction between the two laws, President Obama could just ignore the debt ceiling and follow the direct implications of the spending and taxation laws. I am not qualified to judge the legality of this course of action. The courts would eventually have to sort it out. The hope is that by then the Congress would have come to its senses and raised the debt limit.
• In the meantime, the White House might try invoking the 14^th Amendment, as Bill Clinton suggested at the time of the last debt ceiling standoff, in 2011.  The Amendment includes the passage “The validity of the public debt of the United States…shall not be questioned.” Again the Supreme Court would eventually have to decide the issue.
• The Treasury could issue “IOUs” to the office supply stores, soldiers, Social Security recipients, etc. The IOUs would just be written acknowledgements of a legal fact: that the government owes these people money. Maybe the Federal Reserve could let it be known that it will honor these IOUs. (There must be something wrong with this, or somebody besides me would have proposed it already.)
• The government writes an option to buy all its property and buildings for $1, and then sells that very valuable option to the Federal Reserve for something like its true value. This proposal has been made by the Yale constitutional expert Jack Balkin last time around, from which I infer that it is not obviously contrary to the law.
• And finally, the most colorful of the proposals: the trillion dollar coin. The Treasury would exercise its legal authority to mint a commemorative coin made out of platinum, with a face value of $1 trillion. The Federal Reserve would then buy the coin for $ 1 trillion, allowing the Treasury to pay its obligations by drawing down its checking account at the Fed up to that amount. This proposal originated in the blogosphere and was one of those anointed by Balkin in July 2011. Paul Krugman greatly elevated its prominence by declaring his support earlier this month.

     Contrary to some fears, none of these proposals need result in the money supply being any larger than it would otherwise be.  The Federal Reserve determines the money supply.  If it creates a new component of money by buying a platinum coin, a property option or IOUs, it can offset it by shrinking other components of the money supply by the same amount, leaving the total unchanged.
     The Obama Administration so far is eschewing gimmicks, and is calling on the Congress to do its job in a responsible manner.  This is the right approach.  
     But in the event that the minority does succeed in blocking a debt increase, it may be worth turning to some legal gimmick to avert the financial and economic catastrophe.   Of the five proposals bulleted above, the platinum coin is the one that seems to have the most experts currently expressing belief in its legality.  It is certainly clever.  Unfortunately, it would probably be the worst from a political standpoint.  The reason is - I am guessing here - there is a fairly high overlap between the debt crazies (defined above) and people who have paranoid conspiracy theories that relate to the Fed, money and precious metals (especially gold, but platinum is too close for comfort). For all I know, some of these people are the same who believe that Obama was born outside the U.S.  (That would fall into the category of deranged propositions, also defined above; but there is no need for us to go there.)  When you are dealing with a crazy person, it is best to avoid anything that would pour gasoline on the flames of his paranoia.  We actually want to win back some of those people who are merely misguided but not really insane.  After all, just getting past the current debt cliff wouldn’t solve the problem, with sequester and shutdown deadlines also looming.   So I’d go for some other legal gimmick, one that would be less likely to feed the paranoia and more likely to continuing chipping away at popular support for the extremists.

[I was interviewed this week on the trillion dollar coin by Boston magazine and radio station WGBH.] 

This blogpost also appeared on Econbrowser, Jan. 17, courtesy of Menzie Chinn.  Comments may be posted there.

Arithmetic and history.  Two of my favorite subjects in school.  I covered some history two posts ago (the Whisky Rebellion).  Let’s do some arithmetic now.

Attention is currently focused on threats of a government shut-down, either when a continuing resolution is required from Congress in March in order to keep the government operating, or a few months later, when an increase in the national debt ceiling is required.  The common description of this showdown as a high-stakes game of chicken has it right.   But some of the Tea Partiers say that their goal is literally to avoid an increase in the debt ceiling - not just as a bargaining ploy nor as an abstract goal, but in the sense that they want to cut spending so sharply that there is no need to borrow any more after this spring.   Similarly, Senators Mike Lee (Utah) and John Kyl (Ariz.) have revived the proposal for a constitutional amendment requiring a balanced budget.  And of course they all want to do it without raising taxes, and in most cases without cutting defense, Social Security or Medicare.   Oh, and don’t cut farm subsidies either.

Not many people want to spend the time learning about the specific options or making the choices that would be necessary in order genuinely to solve the budget situation, even though a couple of useful websites make it relatively easy to think through the alternatives (NYT or PPC).  

But the proposition that we could eliminate the budget deficit through sufficiently drastic cuts in domestic spending is so far out of line with reality, that the point can be made easily to even the most innumerate congressman.  Here is the arithmetic. 

Total federal spending is $3 ½ trillion in round numbers.    That spending number minus tax revenue left a budget deficit of $1.3 trillion in fiscal year 2010.   Putting aside a very small number of genuinely sincere libertarians like Ron Paul, most Republican congressmen want to exempt defense spending and senior-related spending (Social Security and Medicare), and to make all the cuts in non-defense discretionary spending.  (That was their official platform in November’s election.)     How much would you have to trim non-defense discretionary spending to balance the budget?   Start — as many people would like to – by eliminating all foreign aid.  Contrary to what they think, foreign aid is of course only about 1% of total outlays.  Next imagine zeroing out all of veterans’ benefits, all federal spending on education, and all federal spending on transportation.   That includes programs so popular with their beneficiaries that the congressmen voting for them would be virtually certain to lose re-election.  But some of the freshmen say they are willing to pay that price, so let’s go full speed ahead.   We are only up to 6% of total outlays.   Now eliminate every dime of non-defense discretionary spending: parks, weather service, food safety, SEC, FBI, border patrol, politicians’ salaries… everything.  Do you think that closes the gap?    It only gets you half way there!   Domestic discretionary spending is not where the big bucks are.

The arithmetic in fact works out quite simply.    Of the $3 ½ trillion in federal outlays, just under 1/5 is non-defense discretionary spending.   Another 1/5^th is defense.   Social security is the third 1/5^th.    Medicare is the fourth 1/5^th (slightly less now, but far far more in the future).    The last 1/5^th is interest on the debt (which will also grow enormously in the future) plus other entitlements.    Numerically speaking, we would have to eliminate not just all non-defense discretionary spending, but also all defense.  Or else all social security spending (but we would have to continue somehow collecting the payroll taxes that are supposed to fund it!).   Or else all Medicare spending.   The unmistakable implication is that a solution to our long-term fiscal problems will have to involve some sharing of sacrifice among each of these five categories.    And increased tax revenue as well.    

Admittedly, the Republican leadership’s goal for the current fiscal year was to reduce domestic spending by “only” $100 billion.   But the freshmen’s position is that this goal is not enough.  (At the same time, they are unable to come up with that much in specific cuts that they are willing to put their names to, for the same familiar reasons.  Domestic discretionary spending is not where the money is.)

A reasonable medium term goal might be to raise taxes as a share of GDP at least to 18%, what it was during the Reagan administration, and to lower spending to 23%, what it was then as well.   Of course these two numbers still leave us with a deficit of 5% of GDP, which was Reagan’s record.  It will take us much longer to get back to the fiscal rectitude of Clinton.   It is not possible to eliminate the need to borrow, in the short run.   

As for the long run, as we all know, the baby boomers are starting to retire and the trends in Social Security and (especially) Medicare are unsustainable.   Ten years ago, if the country thought it was important enough to protect any single category against belt-tightening in the long run - say social security or taxes - it would have been arithmetically possible, by making the cuts elsewhere.    But we no longer have the luxury of such choices after the legacy of the last decade — after the effects of mammoth tax cuts (starting in 2001 and 2003), two wars (2001, 2003), the Medicare prescription drug benefit (2003), and the severe financial crisis and recession (2008).   Starting from our current position, each of the five components must play a role, along with taxes.

Many commentators faulted President Obama for not proposing to cut entitlements when he submitted his budget in early February. They sanctimoniously intone that a true leader would realize that the public wants to hear the truth.   I don’t understand how they can say that with a straight face.   Obama came into office with a mature desire to put childish things aside and a naïve eagerness to be bipartisan.  The response he got was accusations of death panels, an explicit Republican strategy to deprive him of legislative successes (no matter what their content), and the electoral defeat of moderate congressmen in both parties. People who say that Obama should stick his neck out to support some of the radioactive proposals of the Bowles-Simpson deficit-reduction commission have apparently forgotten that he originally asked for ex ante bipartisan blessing for the formation of the commission and a congressional vote on its recommendations, but the Republicans refused.  

It is clear as day that if he broached the sort of specific proposals that are necessary, such as raising the retirement age in the distant future, he would be attacked simultaneously for hurting seniors and for not going far enough fiscally (and it would in many cases be the same people making both attacks, inconsistent as that is).  The point is not just that he would hurt himself politically.  The point is that the inflammatory attacks on the proposals would then entrench positions and make it harder to enact the reforms in the future, not easier.  The White House has explained the danger of “poisoning the well.”  There is no alternative to preserving the true remedies for some future venue where both sides are willing to join hands and make the necessarily compromises together.   We have known this political fact for 30 years.  Savvy media commentators would do the same if they were working in the White House; but they don’t consider that criterion relevant when fashioning their critiques.  They have their own audiences to play to.