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HICKS: Without real cuts, cost of borrowing will rise

July 9, 2011

The debate over the debt ceiling seems a bit more complicated than it needs to be. Fundamentally, it is quite simple.

Each year, Congress passes a budget based on estimates of tax dollars collected and the cost of such things as Medicaid, national security, etc. Along with this budget, Congress usually allows the U.S. Treasury to borrow extra money to make these payments. This borrowing limit sets the debt ceiling.

The treasury handles the accounts and reports on tax shortfalls, or excess spending needs. If there is a big imbalance, Congress must authorize the treasury to borrow more money. That is where we are now. The treasury needs to borrow more money; otherwise, it won’t be able to pay doctors and soldiers for the aforementioned Medicaid and defense. But that isn’t really the worry. It is those who have lent us money who rightfully feel themselves to be at risk if the United States does not make interest payments on the loans.

To no surprise, if the United States fails to pay the interest on the money it has borrowed, future lenders will be less eager to lend us money. Thus, interest rates on these loans will rise and the cost of our debt will increase from its already astonishingly high 18 cents on every dollar of tax revenue. This should be most unwelcomed, but it is only half the story.

The cost of continued borrowing will also rise if Congress does not dramatically cut spending. To be sure, Congress can also raise tax rates, but it is not at all certain that, over the long run, higher tax rates will actually boost tax revenue. What is abundantly clear is that federal spending is much higher than is currently sustainable.

The fight in Congress is about how much and from what part spending must be cut. The positions are familiar and lack political consistency. President Obama voted against raising the debt ceiling when the roles were reversed—a flip-flopping matched by both parties.

Agreement on the level and scope of cuts is likely. The real disagreement centers on any consideration of tax increases, and even what might be considered a tax increase. In this arena, I think the Republicans risk making a significant policy error that will haunt them for years to come.

Obama has proposed the elimination of dozens of tax loopholes and subsidies. Many of the tax loopholes and subsidies he proposes are part of the road to fiscal solvency. We currently subsidize oil companies to drill for oil, pay farmers not to grow corn, and thousands of other silly tax games. Eliminating these programs is not a tax increase and fiscally conservative members of Congress should be able to find hundreds more examples to eliminate.

Without real expenditure cuts, the cost of borrowing will rise regardless of what happens to our debt ceiling. This is a prime time to also clean up our tax code in the process.•

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Hicks is director of the Center for Business and Economic Research at Ball State University. His column appears weekly. He can be reached at cber@bsu.edu.

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