The Debt Ceiling: A Primer
by Jacob G. Hornberger
Just as I have predicted several times since the debt ceiling was last lifted in 2013, statists are saying that a catastrophe will ensue if the debt ceiling isn’t lifted again. Treasury Secretary Jack Lew is leading the charge, exclaiming in a USA Today piece that “by waiting to the last minute to act on the debt limit, Congress could cause a terrible accident.”
To examine exactly what the debt ceiling debate is all about, let’s return to basics.
The first thing to ask is: How does the federal government get its money to pay for salaries of federal employees, to make welfare payments, and to pay for the bombs it drops on people?
The answer is: through taxation. The primary federal tax is the income tax, whereby the government requires people to pay a certain portion of the income they receive to the government. If someone earns $30,000 and the income tax rate is, say, 33 percent, he will have to pay the federal government $10,000, and he gets to keep $20,000. If he fails or refuses to pay, the IRS will come after him with criminal prosecution and with seizure of his assets.
Let’s assume, for simplicity’s sake, that after everyone has paid his taxes, the government’s total tax revenue is $1 million. Let’s also assume that total government expenditures total are also $1 million. That means that all the entire $1 million in tax revenues will be spent — to cover such things as salaries for employees, welfare payments, bomb purchases, and the like.
That is what we call a “balanced budget,” one in which the government’s tax revenues equal to the government’s expenditures.
Notice something important here: Even though the government is spending the same amount that it is bringing in with taxes doesn’t necessarily mean that what the government is doing is good, moral, or sound. While the government might be behaving in a fiscally responsible manner with its balanced budget, it nonetheless might still be, for example, waging its failed and destructive war on drugs or continuing to kill people on a daily basis in faraway lands. That’s why people’s focus should always be not only on fiscal responsibility but on the much more important question of: What should the federal government be doing and not doing?
Suppose the government’s tax revenues are instead $1.2 million. In this case, the government has collected more than what it spends. This is what we call a “budget surplus.” The government has collected $1.2 million and has spent $1 million.
Suppose, however, that the federal government collects $1 million but spends $1.2 million. What then? This is what is known as a “budget deficit.”
But there is obviously a problem. How can the government spend the extra $200,000 when it hasn’t collected it in taxes?
One option would be to reduce the level of spending to match the amount being collected by taxes. That would obviously mean cutting $200,000 from people’s welfare payments, reducing the number of bombs being used and replaced, or laying off some DEA agents. In that case, $1 million in tax revenues would equal $1 million in expenditures.
The problem, however, is that the people who are at the receiving in of those proposed reductions begin screaming like banshees. “We are dependent on our dole and we have a right to continue receiving,” the welfare recipients scream. “If we don’t continuing dropping the same number of bombs on people, national security will be threatened,” the warfare statists cry. “If we’re not busting the same number of drug users, we will lose the war on drugs,” the drug warriors exclaim. Their acolytes, both inside and outside of the federal government, cry, “Catastrophe!”
Unable to withstand that type of pressure, federal officials look for a way to keep spending $1.2 million, even though they are collecting only $1 million in taxes.
That’s where borrowing comes into play. The government goes to people in the private sector and says, “If you will loan us $200,000, we promise to pay you back in 12 months with interest.”
People in the private sector make the loan and the government goes ahead and spends $1.2 million, with $1 million coming from taxes and $200,000 coming in the form of borrowed money.
A problem arises in the following year. The government now owes people $200,000, which it has to pay in addition to its other regular payments. Let’s assume that tax revenues remain at $1 million and expenditures stay at $1.2 million. Now the government is faced with a bigger problem than the previous year. Not only does it not have the money to pay the $200,000 deficit between tax revenues and expenditures, it also doesn’t have the $200,000 to pay off the previous year’s debt.
One option is to reduce federal spending to $800,000 which would enable U.S. officials to run a $200,000 budget surplus. Under that scenario, tax revenues equal expenditures, plus an extra $200,000 surplus, which is used to pay off the previous year’s debt.
On a practical basis, that’s not what happens. Instead, unwilling to reduce spending, federal officials go out and borrow $400,000, which they use to pay off last year’s $200,000 debt and also to cover this year’s budget deficit.
Now the government has a bigger problem: It now owes $400,000 rather than $200,000.
Imagine that this goes on for 25 years. The government’s debt has now reached $1 million, which is equal to the amount that the government collects in taxes. If the government uses all its tax revenues to pay off its debt, that leaves no money to pay the welfare recipients, the bomb makers, the DEA agents, and the rest of the federal bureaucracy. Or if it pays all those people, it defaults on its debt payment.
Inevitably, a time arrives when the government is unable to handle all its expenditures, including the repayment of its debt. That’s when the government is effectively bankrupt.
That’s what happened to Greece. The amount of the government’s debt became so large that it simply became impossible for the government to pay its expenditures and repay its debt with its existing level of tax revenues. Raising taxes would only exacerbate the problem by sending businesses into bankrupty, thereby adding more people to the welfare rolls. That’s when the Greece government went belly-up.
Thus, too much debt is a very bad thing, a very dangerous thing. That’s precisely why Congress enacted a “debt ceiling” in the first place. The debt ceiling is simply a maximum amount that the federal government is permitted to incur. The reason Congress put it there is because of the danger of incurring too much debt.
Another problem, however, is that every time the debt ceiling is reached, the welfare-warfare state recipients, along with statists in the private sector, who include the mainstream press, start screaming about the “catastrophe” that will ensue if the government isn’t permitted to add to the already high level of existing debt. “Don’t cut our dole!” they all cry.
So, rather than drastically reduce spending and running a surplus, which would enable the government to begin retiring the debt, federal officials simply lift the ceiling and kick the can further up the road, knowing that the new ceiling won’t be reached for another couple of years. Meanwhile, by doing so, they permit more debt to be incurred until the next time the new debt ceiling is reached.
There is something important to note about all this: Each time the debt ceiling is reached, the statists who were crying “catastrophe” never demand that the government begin reducing expenditures in anticipation of the next time the debt ceiling is reached. In fact, they demand the exact opposite — that the federal government keep spending more than what it is bring in with taxes, knowing that they will be able to scare public officials into lifting the debt ceiling again by screaming “Catastrophe!” every time the new debt ceiling is reached.
The solution to all this spending is obvious: Don’t lift the debt ceiling. That is, don’t permit federal officials to add to the already existing level of federal debt. That would mean that the federal government would be force to have taxes equal expenditures — i.e., a balanced budget — or possibly better a budget surplus.
Refusing to lift the debt ceiling simply means no more new borrowing. That would mean that the government would be forced to reduce spending by the amount of the deficit. That would mean reduced federal expenditures—e.g., lower welfare payments, reduced bomb purchases, and layoffs of DEA agents. Ideally, from a libertarian standpoint, it would mean abolition, not reform or reduction, of welfare-warfare state programs.
Otherwise, if the debt ceiling is lifted once again — as it has been 78 times — the federal government’s debt situation only grows more precarious, dangerous, and ominous. Just ask the people of Greece.
One more thing: Prepare yourself.