For the first half of 2023, Washington once again debated whether and how to raise the limit on federal borrowing. Failing to extend the debt limit would have been catastrophic, requiring an immediate 30 percent reduction in federal spending, defaulting on payments owed to countless businesses, and possibly even triggering a financial crisis by defaulting on the federal debt itself. Yet some lawmakers asserted that causing such a default would be a responsible way to curb federal spending. In the end, Congress and President Biden raised the debt limit at the eleventh hour by attaching legislation that set up modest future spending cuts, while admitting that they had no plans to follow through on them. With Washington scheduled to do this again when the debt limit gets reimposed in early 2025, it’s time to consider replacing the limit with a better mechanism for constraining debt.
The debt limit is a relic from the early twentieth century. It replaced a system in which Congress voted separately to authorize borrowing for every deficit-financed bill. Today, the debt limit serves as a check on runaway deficits, but it has become less effective in this role; in effect, it’s a hostage that can’t be shot. The debt limit motivated deficit-reduction legislation in the 1980s and 1990s (turning a 6-percent-of-GDP deficit into a budget surplus); but over the past decade, it has more commonly served as a vehicle for deficit-expanding legislation. Debt-limit fights also startle financial markets, likely raising the interest rate that Washington must pay.
Repealing the debt limit will not by itself encourage fiscal responsibility. Indeed, while the debt limit is a poor tool for reducing the deficit, it’s also the only vote that Congress takes that cumulatively addresses all spending and taxes. Congress no longer reliably passes annual budget resolutions, and those that it does approve are nonbinding and easily ignored. Simply focusing on the cost of new laws ignores the nearly 73 percent of federal spending that grows automatically—including deficit-drivers Social Security, Medicare, and Medicaid. Most of the tax code is also on autopilot. The result: budget deficits projected to hit $3 trillion within a decade and a national debt projected to surge toward 200 percent of GDP within three decades.
Congress and the White House need some legislative mechanism to settle on a multiyear spending, revenue, and debt target—a framework to set priorities and trade off various tax-and-spending goals. Within an IMF database of 106 nations, the U.S. is one of only three without any rules covering budget deficits or debt. Even much of left-wing Europe limits annual spending, deficits, or debt (though enforcement levels vary).
The U.S. should replace the debt limit with a law capping the size of the federal debt at the current level of 100 percent of potential GDP. With neutrality between tax increases and spending cuts, targeting federal debt levels can appeal to both liberals and conservatives. Limiting the debt to the size of the economy would let Washington run budget deficits of roughly 3.5 percent annually, and likely ensure that federal interest costs stabilize between 3 percent and 5 percent of GDP (depending on interest rates).
Congress can debate the mechanics of such a cap. Measuring the debt against potential GDP (which adjusts for booms and recessions) would prevent painful consolidations whenever the economy slips into recession. Congress could require a supermajority vote to pass any bill that would push the projected long-term debt over the cap. Debt overages driven by automatic spending and tax policies could trigger automatic spending-and-tax changes (unless Congress enacts alternative savings reforms). Even supermajority-approved overages could require savings to return the debt gradually to its 100-percent-of-GDP target.
No fiscal rules are perfect. Any law can be repealed by another law, and too little flexibility risks constraining policymakers during emergencies. Yet with most economists agreeing that the federal debt is on a dangerously unsustainable path, even an imperfect fiscal rule would be an improvement on the debt limit.