The Agenda

Why the White House Will Win a Debt Limit Standoff


Matt Yglesias looks at the apparent collapse of talks on raising the debt ceiling and concludes that we’re headed for an impasse, where the federal government will soon have too little money to pay its bills. This won’t lead to a default on debt. Instead, the Obama Administration will follow a payment prioritization strategy:

[Y]ou want to try to stiff people to whom the government owes money but who will probably keep working even if you don’t pay them. Take defense contractors, for example. If Robert Gates tells a bullet-making company that he can’t pay the Pentagon’s bills this month because Eric Cantor is being obstinate, but please keep sending bullets anyway, the bullet-makers aren’t going to leave our troops bullet-less. We just need to tell them to keep sending the invoices coming, and promise that all bills will be paid once Cantor relents. Hospitals, doctors, and other Medicare providers are the other low-hanging fruit here. Patients will continue to be treated, doctors will keep filing paperwork, and Kathleen Sebelius will keep reassuring people that they’ll be paid when the congressional gridlock is resolved.

Over time, of course, these tactics tend to run into limits. We may need to start paying people less than their full Social Security checks, mailing a partial benefit plus a note explaining that back benefits will be paid once congress lifts the debt ceiling. My intuition is that various government contractors, doctors, hospitals, etc. will put enough pressure on congress to break the deadlock before these Social Security notes need to start going out. But in political terms it’s a very winnable fight for the White House, and in substantive terms doing it this way should minimize impact on the nation’s credit.

Yglesias is right here, but he misses one of the biggest classes of payees that can expect to get stiffed: state and local governments. In 2008, states and localities had total revenues of $2.66 trillion; of that, $481 billion was aid payments from the federal government.

Governments are a good payee to stiff because they are relatively able to handle a delay of payments, compared to (say) Social Security recipients. If a state doesn’t get the money it expects from the federal government, it can issue revenue anticipation notes to cover the gap. If granny doesn’t get her Social Security check, she might not be able to pay rent or eat. There’s a reason that Illinois’s famous $8 billion backlog of unpaid bills consists mostly of payments due to local governments and public authorities.

Effectively, delaying payments to state governments (which account for over 90 percent of the federal aid to states and localities) is a way of getting around the debt cap: states will borrow the money that the federal government isn’t allowed to. But state lawmakers aren’t going to like this situation one bit: it will be a huge financial management headache, it will force some of them to violate their own balanced-budget rules, and it will put them on the hook for debt service costs that were supposed to be covered by the feds.

So, you can add state lawmakers (from both political parties) to the list of people likely to be demanding a debt limit increase from Congress once the impasse arrives. People hate the idea of raising the debt limit, but they really hate the idea of not getting paid. It’s yet another reason to expect that, like Ronald Reagan and Bill Clinton before him, Barack Obama will win his fight with Congress over the debt limit.

Josh Barro — Mr. Barro is the Walter B. Wriston fellow at the Manhattan Institute. His research is focused on state and local fiscal policy.


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