An analysis of fiscal policy under a debt limit

The economic consequences of a default on the national debt would be catastrophic to the nation and the world economy. The debt-limit dispute has forestalled discussion of rational budget changes and entitlement reform. President Biden has the legal authority to ignore the debt limit and pay the nations bills. House Republicans have many other ways to pursue their agenda.


The current standoff over the debt limit between House Speaker McCarthy and President Biden reminds me of the line in the movie Cool Hand Luke “What we have here is a failure to communicate.”

The Speaker’s position is that there will be no increase in the debt limit without substantial reductions in spending.

The President has refused to negotiate over the debt limit and would deal with Congressional efforts to trim the budget through the normal appropriation process.

This post evaluates the debt limit conflict.

The status of debt-limit proposals:

The Speaker of the House has taken the position that he will not support an increase in the debt limit unless it is accompanied by substantial reductions in spending.  House Republicans differ on the type of spending cuts they support.  Many of the cuts in a House bill would not pass the Senate.

The current House Republican proposal discussed here contains the following items:

  • An increase in the debt limit by $1.5 trillion or until March 2024, whichever comes first,
  • Cancellation of the Biden Administration student debt discharge proposal,
  • The reinstatement of student loan payments, halted by executive order during the COVID pandemic,
  • Prevention of the enactment of changes to Income Driven Loan plans,
  • Rescission of newly appropriated IRS funds,
  • Creation of a work requirement for federal assistance programs including SNAP and Medicaid,
  • Elimination of tax credits for electric vehicles and other solar and wind projects enacted in the Inflation Reduction Act,
  • Reduction in funding from 2024 levels to 2022 levels and a limitation of annual funding increases to 1.0 percent.

Several aspects of the debt-limit dispute are examined here in more detail.

Concern One: Economic Issues

 A debt default by the United State is an existential threat to the national and world economy

  • Federal benefits including Social Security and Medicare and Medicaid payments would be disrupted.
  • Substantial amount of world trade, which is denominated in dollars would be disrupted.
  • Investors would dump Treasury securities and interest rates would rise.  
  • The stock market would fall drastically.
  • The duration of the stock market decline and interest rate spike would depend on duration of default.
  • The dollar would likely lose its status as world’s reserve currency.
  • Recession and stagflation would likely ensue.
  • Assistance to Ukraine would be disrupted.

Concern Two:  Legal and Constitutional Issues

Legal experts differ on the ability of the President to pay bills, maintain benefits, and raise new funds should Congress fail to increase the debt limit.

  • The founders of our nation did not envision a situation where one part of a divided Congress could dictate massive policy changes to the other part of Congress and the Executive.
  • Many legal scholars believe the President has the authority to ignore the debt limit when congressional actions create unconstitutional doubt about the validity of the public debt.  See this note.
  • Congressional Republicans have many levers including the normal appropriation process, court action, government closure to reduce spending.
  • Supreme Court should stay out of this dispute between Congress and the President.  Congressional Republicans have an impeachment option if they believe the President’s actions are illegal.

Concern Three:  Fiscal and Budgetary Issues

Many items in the Republican agenda are severe and have little support in the Senate.  However, some items have merit and could be enacted in a different political environment.

  • The simultaneous enactment of the Republican fiscal agenda with Federal Reserve monetary tightening would result in a severe recession.
  • Fiscal policy is already becoming more stringent because of the end of COVID relief programs and automatic phaseouts of some programs.
  • The COVID-era Medicaid expansion has lapsed.  Go here for a discussion of the impact of the end of this benefit.  Additional Medicaid work requirements would further increase the number of uninsured.
  • The current proposal does not appear to target the ACA.  However, the elimination of the ACA subsidy cliff automatically phases out in 2025.
  • A strong case could be made for modification of the EV tax credits, which I have argued  here are regressive and a costly way to motivate more rapid introduction of EVs.
  • The Biden Administration student discharge proposal is not clearly connected to the COVID pandemic and could be eliminated by litigation currently before the Supreme Court.  The Biden Administration and Congress should consider revisions to student debt programs described here.
  • The reduction of SNAP programs would substantially increase hunger in America.
  • The limitation of future expenditures to an annual increase of 1.0 percent is problematic given that inflation remains above 5.0 percent.
  • The proposed recission of funds for the IRS would increase budget deficits.
  • The proposed reinstatement of the debt limit prior to the election is a political non-starter.
  • The debt-limit threat has caused the Administration to delay replenishment of the strategic petroleum reserve.

Concern Four:  The Role of Entitlements

The current budget debate ignores key issues pertaining to the future of Social Security and Medicare.  This is a huge mistake.

  • The trustees of the Social Security Trust fund project that declines in Trust fund assets will trigger automatic Medicare benefit cuts in 2028 and automatic cuts to Social Security in 2033.  Go here for part of this discussion.
  • The existence of a debt-limit dispute in a year where the Trust Fund balance dictates automatic reductions in either Medicare or Social Security benefits ncreases the likelihood of benefit reductions.
  • The delay in the entitlement discussion could result in abrupt entitlement benefits in the future.  Go herefor a discussion of why changes to Social Security need to be phased in slowly and coupled with improvements to private retirement savings.

The decision by both the Republicans and the Democrats to delay discussion of entitlement reforms increases the likelihood that the reform process will result in a less than optimal outcome.

Concluding Remarks:  Down-to-the-wire disputes over the debt limit are never good for the economy, for the markets and are not an effective way to deal with increased debt levels or wasteful spending.  Government closures also aren’t good for the country, but the economic consequences of a government closure are infinitely less drastic than a default on the debt.  

President Biden must make clear that the debt default is not going to happen.  The only way for the President to remove the uncertainty of a debt default is to announce that he will ignore the debt limit and pay the nation’s bills, an action supported by many legal scholars.

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