2011-07-15

The 14th amendment and the possible government shutdown

Oh dear:
Crisis talks on the United States' debt limit remained deadlocked overnight as negotiations led by US president Barack Obama degenerated into a slanging match.

The president is said to have stalked out of the latest debt talks, which both sides have acknowledged as the most heated yet.

"This may bring my presidency down, but I will not yield on this," Mr Obama is quoted as saying.

The prospects of politicians reaching a deal to raise the debt ceiling are still in question after fifth straight day of talks.
Some econ bloggers have pointed out that the 14th Amendment of the United States renders the "debt ceiling" unconstitutional:
The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned. But neither the United States nor any State shall assume or pay any debt or obligation incurred in aid of insurrection or rebellion against the United States, or any claim for the loss or emancipation of any slave. But all such debts, obligations and claims shall be held illegal and void.

My view is that the "debt ceiling" is not unconstitutional. What is unconstitutional is to default on this debt. Let me explain.

All the "debt ceiling" does is prevent the government from borrowing any more money beyond the previous predetermined limit. Since congress has the power under the constitution to legislate borrowing and spending bills, any self imposed limit on the amount of money the federal government borrows is entirely within their purview.

So what happens when congress doesn't increase the debt limit a "government shutdown" is initiated?

All it means is that the government will have to cut spending in order to fit into the amount of money they do receive. Spending must be cut. And if we believe that the 14th amendment will be followed, then we can assume that paying back interest and principal on money borrowed will not be affected at all. Instead, spending cuts will be made to other areas of government control. Spending on health care will be cut drastically. Military spending could possibly be cut. Social Security spending cuts would only occur if the spending is not considered "government debt".

My spreadsheet tells me the following about US government debts and receipts:


So if revenue represents 16.61% of GDP and spending represents 25.29% of GDP, then any failure to increase the debt ceiling will force the federal government into spending only as much as it gets. This would mean 16% spending instead of 25% spending. In short, it would reduce the spending size of government by around two-fifths. You can imagine how devastating such an action would be upon the economy.

But what about government debt? The last time I checked, interest paid on government debt made up around 2.8% of GDP. Even after a potential failure to increase the debt ceiling, interest on treasury bonds and other debts will have ample room to be paid back.

A failure to raise the debt ceiling will most certainly shrink government spending, but it will not result in debt default. The unemployed will no longer be given payments, Medicare will grind to a halt, NASA will disappear, even social security has the potential to be scaled back... but at least those who lent the government money will get their interest - hardly a cause for celebration.

To summarise the 14th amendment on this issue: The amendment doesn't invalidate a debt ceiling, it just ensures that government debt will be paid off even if any debt ceiling isn't increased.

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