Witnesses: Both default on debt and deep spending cuts would cause lasting economic damage
Rare, bipartisan agreement broke out in a Senate subcommittee hearing this week when Democrats, Republicans, and both conservative and progressive economists agreed that the U.S. must avoid defaulting on its debt later this year.
Some House Republicans have said they will not vote to increase or suspend the debt ceiling unless Democrats and President Biden agree to sweeping cuts in domestic spending. But some witnesses who testified Wednesday before the Committee on Banking, Housing & Urban Affairs Subcommittee on Economic Policy said that approach would also result in sweeping job losses, a huge spike in the unemployment rate, and damage to the economy that would take a decade or more to repair.
Some time this summer or fall, the U.S. will default on its debt unless Congress acts. The exact date on which this could happen is unknown, although Mark Zandi, Chief Economist for Moody’s Analytics, said he and his team of researchers have calculated that the date will fall on August 15.
“It is unthinkable to me that the U.S. Congress will not extend the debt ceiling,” said Sen. John Kennedy (R-LA), who added that even though he voted against a number of spending bills advanced by Democrats, the bills did become law and the federal government is obligated to fund them. “There is a moral and practical principle involved,” he said. “If you are going to have a party, you have to pay the band. And we are going to pay the band.”
Zandi testified that damage will occur to the nation’s economy even if the U.S. defaults on its debt for a very short period of time – in other words, if the deadline for action passes and lawmakers days later vote to increase the debt ceiling.
“Much damage will have already been done, and although markets would right themselves, it would be too late for the already fragile economy, and a recession would ensue,” he said. “However, if lawmakers do not reverse course quickly and the impasse drags on for even a few weeks the hit to the economy would be cataclysmic.”
He said, for example, that if the debt limit was breached on October 1 and debate dragged on the entire month without action, the Treasury Department would have to cut spending by $125 billion. If debate lasted through November, another $200 billion would have to be cut. “The hit to the economy as these government spending cuts cascade through the economy would be overwhelming,” he said.
Zandi warned that a long-term default would cause a loss of 7 million jobs in the U.S., raise the unemployment rate to more than 8 percent, and lead to a 20 percent drop in stock prices, wiping out $10 trillion in household wealth.
But Zandi emphasized that even if default on the debt is avoided, tremendous damage to the economy will result if House Republicans are successful in their efforts to slash domestic spending. His prognosis:
“Given the dramatic reduction in government spending in this scenario and the already fragile economy, the economy suffers a recession in 2024, costing the economy 2.6 million jobs at the worst of the downturn, pushing unemployment to a peak of near 6 percent,” he said. “The economy’s long-term growth prospects are also meaningfully diminished given the severe fiscal restraint. A decade from now, real GDP is 2.7 percent lower than if there had been a clean debt limit increase, equal to more than one year’s worth of typical GDP growth.”
Some House Republicans plan to move legislation this week that would allow the Treasury Department – in case of a default – to pick and choose who gets paid and in what order. But one conservative economist, Douglas Holtz-Eakin, who served as head of the Congressional Budget Office, chief economic advisor to Sen. John McCain (R-AZ) during McCain’s 2008 presidential campaign and also worked as chief economic advisor under President George W. Bush, said that is a terrible idea.
“It has been asserted by some that the Treasury could avoid default by prioritizing payments of interest and principal, while deferring payment on other obligations,” said Holtz-Eakin, President of the center-right American Action Forum. “I will leave it to the legal community to adjudicate whether the Treasury has legal authority to simply ignore signed contracts and legislated benefits and simply note that I have no faith that it has the operational capability to execute this notion over any substantial time period. Failure to act in a timely fashion is default.”
The Senate panel also heard from Amy K. Matsui, Director of Income Security and Senior Counsel for the National Women’s Law Center. Matsui testified that Congress should raise the debt ceiling “without conditions” and that this action should be followed by passing progressive tax measures that would raise needed revenue by ensuring that the wealthiest Americans pay their fair share.
If there is a default, Matsui argued, among those who would be most harmed are women and people of color – the same people who have borne the worst of the COVID-19 pandemic. “Households across the country would feel direct impacts ranging from unemployment, to delayed receipt of critical federal benefits like Social Security, Supplemental Nutrition Assistance Program benefits, and housing assistance, to increased interest rates on consumer debt and mortgages,” she said.
Matsui added that raising revenue through more progressive tax policies would “support a more robust economy, and broadly shared prosperity if invested in public supports for caregiving, accessible and affordable housing, and other kinds of infrastructure. These revenues could also be used to reduce the amount of federal debt.”
And she said Congress must protect funding – passed last year as part of the Inflation Reduction Act – that will allow the IRS to pursue the wealthiest Americans who evade their taxes. She cited a study released by the Treasury Department’s Inspector General that found in tax years 2014 and 2015, the IRS failed to pursue more than 300,000 high-income individuals who did not even file tax returns.
“Today, the path forward for the Congress is clear,” Matsui concluded. “Raise the debt ceiling, without spending cuts or other conditions; raise additional revenues through fairer and more progressive tax policies; and protect IRS funding.”