No Deal in Sight as Debt Deadline Nears

by Matthew Glans on May 17, 2011

Capitol Hill has been abuzz in recent days about the debt limit that was reached late last week. Debate over how to approach the growing federal spending and debt problems has become increasingly polarized, with both parties taking hard stances on both spending cuts and tax increases. In a new article published Sunday in the Frum Forum, Eli Lehrer, Vice President at The Heartland Institute, argued that both parties may need to step away from their hard political stances to correct a growing debt problem. Eli warns that a lengthy delay in addressing new debt could lead to a situation where bond raters would downgrade their ratings of federal debt, creating an even greater recession.

“The situation deserves serious attention because, at some point before any official deadline, if bond raters get jittery enough to downgrade the debt this alone could cause a recession. It could be a day before an official deadline or several weeks but, at some point, a debt downgrade—which would sent interest rates soaring and business plummeting–could happen without an actual default if investors begin to think default is likely.

Bond ratings, basically, assess the chances of default and, if a politically caused default is likely, credit will freeze up. Because other countries don’t have debt ceilings–or, for that matter, legislatures that are co-equal branches of government—there’s no exact precedent for a downgrade happening in these circumstances but the logic of bond rating suggests that one would take place and a recession would follow.  And Republicans—a few of whom on the party’s fringes seem to relish in the idea of forcing a default—need to be careful of what they wish for: even a debt downgrade would hurt the party terribly.”

Lehrer argues that no tax hikes of any kind stance of some Republicans in Congress could end up hurting both the economy and their political chances in the long term. By considering some tax cuts alongside entitlement reform, Republicans can help improve the debt problem while not conceding too much ideological ground to Congressional Democrats.

“Furthermore, if they want to reach a compromise that actually reduces the deficit and stabilizes finances, Republicans have to consider some actions that some might brand as tax increases.  By taking an entire category of activity off the table, Republicans tie their own hands. In some cases, like eliminating narrow revenue expenditures, indeed, “tax increases” are a good idea on its own terms. (Small tax-code favors function like spending in economic terms and distort the economy.)

If combined with meaningful entitlement reforms — particularly benefit cuts for the well off — payroll tax changes that increased revenue could make sense. But a “no tax increases of any kind, ever” pledge — which, interestingly, not even Grover Norquist’s Americans for Tax Reform demands of federal officials — actually weakens Republicans’ negotiating position by forcing them to consider only absolutely “pure” courses of action.

If Republicans really stick with a total purist position, in fact, they’ll play into the Democrats hands: Democrats could promise all sorts of really attractive tax code reforms that increase revenue by even a little simply to have Republicans reject them.”

Eli’s article, “No Deal in Sight as Debt Deadline Nears,” was originally posted in the Frum Forum May 15 and is available online at:

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