Debt Ceiling Uncertainties

By Loren Adler, Shai Akabas

Tuesday, January 31, 2012

Updated Projection: The Debt Ceiling Slouches Toward 2012

Updated February 3, 2012

A few media stories about the possibility that the U.S. sovereign debt may breach its now $16.4 trillion ceiling before the upcoming November election require elaboration and perspective. The stories cite a combination of slow economic growth in the United States and deepening turmoil in Europe as the rationale behind an accelerated forecast. In our previous posts on this subject (here and here), we have emphasized our assessment that, in the absence of unexpected events, the debt ceiling would not again be reached until calendar year (CY) 2013.

The question now is quite simple: In light of reduced global economic growth forecasts by the International Monetary Fund and the World Bank, threatening noises in the Middle East, and bad news out of Europe, have we fundamentally altered our projection?

No.

BPC’s estimate from last fall was based on “consensus” economic and policy assumptions at the time. The primary economic factor involved is the strength of output, which directly affects the level of revenues collected by the federal government. If the Treasury takes in fewer funds than it anticipates, and therefore accumulates debt at a faster pace to pay for present spending, then the debt ceiling will be reached more rapidly. Thus far, however, the strength of the economy remains only modestly below last fall’s projections.

A somewhat more significant impact on revenues was discovered in the Congressional Budget Office’s (CBO) Budget and Economic Outlook, released this morning. The report found that for reasons not fully understood, corporate tax receipts have been weaker than expected given the strength of corporate profits. This has the effect of depressing revenues and thereby widening annual deficit projections.

On the policy front, two relevant major legislative actions (or, in one case, inaction) have taken place. First, the Joint Select Committee on Deficit Reduction (JSC) failed to reach its goal of agreeing to $1.5 trillion in deficit reduction, which according to the Budget Control Act of 2011 (BCA), would have increased the debt ceiling by an additional $300 billion. But our baseline assumption was that the JSC would agree to no more than $1.2 trillion in budget cuts, and therefore its inaction does not alter the original estimate.

Second, Congress passed a two month extension of expanded unemployment insurance benefits and the payroll tax holiday, and is currently deliberating a further extension through the end of 2012. This can be categorized as additional deficit spending that will move the debt ceiling date closer to the election.* (Any offsetting deficit reduction is likely to be back-loaded in the ten-year budget window, thereby having little effect on the debt ceiling issue.)

Other forthcoming decisions – many of them coming to a head in this year’s lame duck session of Congress, such as the Bush tax cuts and the pending sequester – will impact the timing of the debt ceiling issue. But since these policy questions only affect spending and revenues that occur starting in CY2013, they cannot play a role in advancing the debt ceiling debate up to November.

Based on assumptions stated in our previous posts and above, our current projection is that the U.S. will run up against its debt limit in late January or early February of 2013. CBO roughly confirmed this projection during its release of its report this morning.

Even with the abject failure of the JSC last fall, and the short-term extension of expanded unemployment insurance benefits and the payroll tax holiday, we believe that one or both of the following events would have to occur in order for a case to be made that the United States could reach its debt ceiling prior to the election: 1) a lapse back into recession in the U.S. (potentially caused by an economic collapse in Europe with substantial financial market turmoil spreading to American financial institutions); or 2) a sizeable fiscal “stimulus” program by the federal government – possibly in the form of military mobilization for a fresh foreign conflict.

If either of these events occurs, then the debt ceiling will be among the least of Congress’ worries.

* To be clear, these projections are based on assumptions that incorporate only those policies in CBO’s alternative fiscal scenario. That baseline includes the payroll tax cut and unemployment insurance deficit spending already enacted for the first two months of CY2012, but not an extension of those policies for the remainder of the year. If those policies are extended, all else equal, the date at which the debt ceiling is hit likely would move forward to calendar year 2012, but still not prior to the November election. If this additional deficit spending is passed, we will release an updated projection.

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2012-01-31 00:00:00