On August 2, even if the ceiling on federal debt is not raised the government will not yet be in default in a technical sense. It will not be able to borrow, but it has enough money coming in each month from collection of federal taxes to service its debts. Without borrowing, however, it will not have enough money to pay noncontractual obligations in full, such as government salaries, and entitlements such as social security, Medicare, and Medicaid, and a host of subsidies. No doubt before the political and economic damage becomes too severe, the Republican radicals in the House of Representatives will relent and the ceiling on borrowing will be raised. Before that happens interest rates may rise, and stay higher, because of doubts about the basic competence of American government. Those doubts, plus the higher interest rates they engender, may deepen the current economic downturn, which in turn will reduce tax collections, increase transfer payments, and in both respects increase the federal deficit.
Why Republicans prefer flirting with failing to raise the debt ceiling by the August 2 deadline to accepting the deal tentatively worked out between President Obama and Speaker Bohner to cut federal spending over the next decade by $3 trillion and increase tax revenues (by reducing or eliminating various deductions and credits) by $1 trillion over the same period (a total reduction of the budget of $400 billion a year--roughly 10 percent) is a deep mystery. No doubt much of the proposed spending decrease and tax-revenue increase would prove to be fictitious, or at least speculative, because based on predictions. But it could put in motion a serious movement to reduce the deficit. It would show that spending was not sacrosanct or increased tax revenues anathema.
The opposition to increasing revenues seems based on concern that higher government revenues reduce pressure for reducing spending; and that is true. Yet what is happening in the states undermines that concern. The deficit states are in the approximate position that the federal government will be on after August 2 if the debt ceiling isn’t raised. The states can’t borrow their way out of insolvency, yet their response has not been just to raise taxes; it has been a combination of raising taxes and cutting spending. If the Democratic Administration agreed to increase tax revenues by one dollar for every three dollars in spending reductions, that would seem to be a good outcome from the Republican standpoint.
One problem is attributable to Obama, though it is not a fault of Obama. Obama resembles such Presidents as Nixon and Clinton in the following respect. They are what the political scientist Stephen Skowronek calls practitioners of “third way” politics (Tony Blair was another), who undermine the opposition by borrowing policies from it in an effort to seize the middle and with it to achieve political dominance. Think of Nixon’s economic policies, which were a continuation of Johnson’s “Great Society”; Clinton’s welfare reform and support of capital punishment; and Obama’s pragmatic centrism, reflected in his embrace, albeit very recent, of entitlements reform. The resemblance between Nixon and Obama is, surprising as this may seem, particularly close. Nixon was a bête noir of the Left and Obama is a bête noir of the Right, in both cases based on their activities before they became President (Nixon’s red-baiting, Obama’s community organizing). But Nixon as President was, and Obama is (or is willing to be, under political pressure), a centrist President. That infuriates the opposition by stealing its thunder, and so provokes a powerful reaction. For the Republicans to have acceded to the Obama-Bohner plan of heavy spending cuts and light tax increases would have conceded the political middle to Obama.
It’s not actually obvious that the current $14 trillion federal deficit is too large, or that the federal government is too large. The problem is that the aging of the population and the growing cost and efficacy of medical technology (technology responsible in part for the aging of the population) portends dramatic increases in federal transfer payments, which may cause the deficit to grow faster than the economy. What is important is not to reduce the deficit but to keep it from growing faster than the economy. Not that that’s easy to do. The growth of the deficit could be slowed (perhaps to zero) by a combination of lower spending, higher tax revenues, and faster economic growth. The problem with the first two measures is that they probably would reduce economic growth in the short term, by reducing people’s disposable income; so even if annual deficits fell, the total deficit as a percentage of GDP might not fall—for it is not at all clear what can be done, even aside from political obstacles, to increase the average annual GDP increase of about 3 percent. Total entitlements spending plus interest on the federal public debt account for about two-thirds of the federal budget. If this component of the budget grows by 5 percent a year (and the rest of the budget is flat) while the economy is growing by 3 percent a year, the deficit as a whole will grow faster than the economy (because 5 percent of 67 percent is 3.35 percent). Hence the urgency of entitlements reform--which cannot however be legislated by August 2.