Making a Debt Deal Work

A s described by James Madison in Federalist No. 84, the United States government was founded upon the principle of resolving competing interests by interaction within divided government — precisely what is required in the current debt-ceiling negotiations.

Opponents of debt-ceiling negotiations argue Congress has a responsibility to authorize debt to pay for previously authorized spending. But Republicans won a 3-million-vote majority in the House in 2022, and they shouldn’t be expected to uphold the work of the previous House, which was controlled by Democrats. Debt-ceiling negotiation offers redress for the inflation and weak growth from the 39 percent increase in discretionary domestic spending since the pandemic began.

Incredibly, despite this dismal failure of wild deficit spending, it is worsening once again, even after the pandemic’s end. In every one of the last nine months but one, current deficits are worse than a year prior, as shown in the below chart:

The greater deficit amounts to 3.8 percent of GDP, fueling inflationary pressure, thus making it more difficult for the Fed to avoid recession.

There is a track record in divided U.S. governments of debt-ceiling agreements with spending provisions. The Gramm-Rudman-Hollings Act of 1985 raised the debt ceiling and provided a balanced-budget target for five years thereafter, to be enforced, if necessary, by automatic spending cuts. Shortcomings in the GRH targets and enforcement led to Gramm-Rudman-Hollings II in 1987, which extended the balanced-budget timetable, still relying upon automatic spending cuts. Both GRH measures took place during the Reagan administration with a Democratic House, while the Senate flipped from Republican to Democratic between the two acts.

Rising deficits with a weakening economy, surging expenses for the savings-and-loan bailout, and the upcoming Gulf War led the George H. W. Bush administration to negotiate with a Democratic Congress, creating the Budget Enforcement Act of 1990, which set category spending caps and instituted “pay-as-you-go” (PAYGO) procedures requiring offsets for any additions to spending or tax reductions. Tax increases accompanied the BEA. Another 1990s debt-ceiling package that contributed to surpluses at the decade’s end was the Balanced Budget Act of 1997, which curtailed Medicare spending through reductions to providers. Here, President Clinton collaborated with a Republican Congress.

The most recent example of combining spending controls with the debt ceiling is the Budget Control Act of 2011. Then, as now, a new Republican House was determined to make an impact on the soaring spending of the first years of a Democratic administration. None other than Vice President Joe Biden negotiated a package of spending caps and automatic sequesters.

Outcomes for these packages have a varied track record. The table below contains data on changes in federal spending and deficits as well as GDP growth, from the year of enactment to the following two years, allowing time for policies to take effect:

The debt/budget packages generally succeeded in trimming spending and deficits while spurring growth. The exception, the package with increased taxes under Bush 41, was a clear failure. It increased spending and the deficit and did not spur growth. It appears growth fell too for GRH I, but that is misleading, since the preceding years were the height of the Reagan boom when inflation came under control and investment-tax incentives were exceptionally strong. Real GDP growth averaged 3.5 percent the following two years, a rate we’d kill for now. Noteworthy is that every one of these packages was significantly amended within a few years. Political coalitions and economic circumstances change in unforeseen ways, and it is wise to focus on near-term effects, not future guidelines unlikely to be attained.

Also noteworthy is that the period of strongest growth during the Obama administration followed the BCA’s spending restraint, especially after the 2013 sequester reduced federal spending by 1.1 percent of GDP, leading to 2.5 percent growth, an unimpressive high, but a high nevertheless. The sequester caused hardship throughout the federal government, especially in defense, but the government-spending cutback created space for higher investment and more growth.

Despite favorable economic results from the Obama agreement, Democrats are determined to avoid its repetition, as they felt Republicans came back the next year asking for more cuts. A multiyear agreement to the end of Biden’s current term might alleviate the concern.

There should be no further nonsense about trillion-dollar coins or the 14th Amendment. These daydreams have no support in precedent, law, the Constitution, or the courts. Neither the Federal Reserve nor the financial markets will agree to act as co-conspirators in getting around the restraints built into our system. Hundreds of billions of dollars of federal debt of questionable legal status would not be purchased on the markets.

It’s time to deal. James Madison and his fellow Founders wanted it this way.