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What We Worry?

How huge and looming is that national debt crisis?

Take a look at this chart:

Notice that interest is only 6% of the pie. That’s with interest rates that are half of historical levels. What happens if that 6% share becomes 12% because interest rates normalize? What happens if interest rates go back to 1970s levels, and the interest share expands to 24% of the pie or more?

We submit to you any increase in the interest rate share to between 12% and 24% would provoke fiscal bloodletting and financial chaos on a scale equivalent to that seen in Southern European Countries, like Greece.

Why would interest rates rise like that? Ask yourself why anyone is buying our debt at half of historical rates right now. The only explanation is that bond markets think we are the least fiscally insane nation in the world. But is that really true? If you take a look at these charts, you will see no real difference between our fiscal policies and those collapsing the economies of Southern Europe:

At some point, if we don’t fix this obviously unsustainable situation, the bond markets are going to look at these trends and say, “Sell T-Bills.” That point is inevitable if we do not fix the national debt problem. When it happens, massive interest rate hikes will follow. And fiscal and financial chaos.

So what’s the plan embedded in the Compact for a Balanced Budget?

The Compact's Balanced Budget Amendment (specified in Article II, section 7 of the bill) is designed the fix the national debt in three steps. Here’s how…

Step one, stop kicking the can on borrowing capacity. Set a firm debt limit that cannot be lifted by Congress unilaterally. If you don’t, then Congress will feel like it can borrow forever and will never be sufficiently motivated to husband resources when appropriating for new federal programs.

The Compact's Balanced Budget Amendment does just that—it limits the federal government’s borrowing capacity to an easily enforced specific dollar amount and prohibits any unilateral Congressional increase in that debt limit. Specifically, the initial debt limit is fixed at 105% of the outstanding bonded debt on ratification of the Amendment. If $20 trillion were outstanding on ratification, the federal government’s borrowing capacity would be constitutionally limited to $21 trillion. Any subsequent increase in this constitutionally-fixed debt limit would then require the approval of a majority of state legislatures within sixty days. Even if state legislatures approved most such proposals, Congress would have no choice but to start thinking about the possibility it will not be able to borrow forever. For the first time ever, Congress would have no choice but to husband resources.

Step two, focus the mind in Washington on spending priorities. When a “red zone” of borrowing capacity is reached, require the President to specify what spending will be delayed and deprioritized—“impounded”—when the debt limit is reached. But don’t give the President unbridled authority to reprioritize spending—as currently happens during the statutory debt limit showdowns when Grandma’s social security check is threatened. Instead, ensure Congress can check and balance the President’s proposed impoundments. Give Congress a simple majority override of the President’s impoundment proposal with alternative impoundments of equal or greater amount. When this process plays out, Washington will have specified its spending priorities, creating a perfect starting point for serious budget negotiations. But you have to make sure the impoundment process plays out leaving enough time before reaching the debt limit, so that those negotiations can actually generate a good budget proposal.

The Compact's Balanced Budget Amendment does just that—it requires the President to designate spending impoundments when 98% of the federal government’s borrowing capacity is exhausted and gives Congress 30 days to override those impoundments with equal or greater amounts with a simple majority vote and no presidential signature required. If the initial debt limit were set at $21 trillion, that means the borrowing capacity “red zone” would be set at $20.58 trillion, whereupon the President would have to start designating impoundments and Congress would have to start considering a specific override. With more than $400 billion in borrowing capacity left over when this process begins, and current borrowing rates at around $450-$500 billion per year, Washington would be forced to put their spending cards on the table with at least 9 months of negotiating space to work out their differences before the debt limit were hit and all spending limited to cash on hand.

Step three, put all revenue options on the table—but don’t destroy the seed corn. If a choice must be made between current and future generations as to who should bear the tax burden associated with the current federal government, the morally correct choice is to place the burden on ourselves, not on our kids or their kids. It is also better public policy because we can mete out political punishment for excessive taxation, whereas future generations cannot repudiate the taxes associated with repaying previously incurred debt. At the same time, we don’t want to continue spending as usual, overshoot the taxation of current generations or raise revenues in ham-fisted ways that threaten the tax base and the economic growth needed to repay the national debt. Instead, fixing the national debt requires encouraging Washington to consider all politically plausible spending reductions before relying on revenue increases, and to favor the adoption of revenue measures that will cause the least economic harm.

The Compact's Balanced Budget Amendment does just that—it requires a supermajority for new or increased income or sales taxes, while preserving the current rule of simple majority approval for new or increased taxes arising from: 1) the elimination of tax loopholes; 2) the replacement of all income taxes with a non-VAT sales tax; and 3) new or increased tariffs (and other revenue sources excluded from the supermajority limit, such as fees). This keeps all responsible revenue options on the table, but it will cause spending reductions to look relatively more attractive as an initial means of closing deficits. Moreover, by encouraging a shift to flatter or more voluntary consumption-oriented forms of taxation, new revenues will tend to be raised only through the adoption of tax policies that provide less favoritism and that do less damage to savings and investment (and economic growth and jobs).

With these three features of the Compact's Balanced Budget Amendment in place, Washington’s political interests would be strongly aligned with generating a balanced federal budget or, at the very least, a much more responsible and sustainable budget, which is a prerequisite of transitioning to a balanced federal budget.

Either way, the days of kicking the fiscal can would be over, Washington’s addiction to unlimited borrowing capacity would end, and Washington would finally be strongly motivated to implement a solution to the national debt problem it created. Bond markets would applaud and interest rates would stabilize at levels that studies of state constitutional debt limits show would be lower than would otherwise be the case.

It won’t happen without leadership from the states.

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