Alexander Hamilton, America’s first secretary of the Treasury, issued the first U.S. Treasury bonds on Sept. 18, 1789. The Continental Congress had borrowed money from overseas to help finance the Revolutionary War and could not pay back its loans. It defaulted on maturing debt in 1786 and couldn’t pay the 625 soldiers of the U.S. Army in 1787. By the time the Constitution went into effect on March 4, 1789, the United States owed $75 million.
That debt would be roughly $900 billion in today’s dollars and was 30 percent of gross domestic product in 1789. Hamilton instructed the Treasury to borrow $19,608.81 from the only two banks in the country at that time (the Bank of New York and the Bank of North America) to pay interest on the new nation’s debt. Repayment of the bonds was secured by revenue from the 8 percent import tariff that Congress had enacted.
So began the long, steep ascent to today’s $16.5 trillion national debt (on which the Treasury pays $19,608.81 in interest every two seconds). The national debt now exceeds 100 percent of GDP and is growing by roughly $3 billion a day. The Congressional Budget Office (CBO) projects a $20 trillion debt 10 years from now.
George Washington warned about the dangers of debt in his Farewell Address (1796), admonishing “the people of the United States to avoid the accumulation of debt.” Forty years later (1835) was the only debt-free year in America’s history. By the time President Clinton gave his final State of the Union address on Jan. 27, 2000, America’s national debt was $5.5 trillion.
Uncle Sam spends more money every year than he takes in. The resulting budget deficits are financed by issuing more Treasury bonds (IOUs), adding to the pile of debt. Annual deficits balloon when wars or recessions cause spending to surge and/or tax revenues to decline. Deficit spending makes debt reduction impossible. Opinion polls suggest Americans want government to stop the deficit spending, so Washington is now fixated on deficit reduction. The CBO says the current debt trajectory will shave 1.7 percent off GDP by 2022.
The U.S. Senate hasn’t passed a budget in four years. Congress sidesteps fiscal responsibilities by passing continuing resolutions that provide “temporary” and “emergency” funding for Uncle Sam. Without those budget Band-Aids, the government would have to shut down, as it did on 17 occasions from 1976 to 1996. The longest (21-day) shutdown was sparked by Mr. Clinton’s veto of a balanced budget that the Republican-led Congress passed in December 1995. That shutdown furloughed 800,000 federal workers, delayed passport and visa processing and closed national museums, monuments and parks.
Recognizing its inability to attain deficit reduction through the annual budget process, Congress created mechanisms of budget enforcement that would compel deficit reduction while providing political cover for the resulting spending cuts. The Gramm-Rudman-Hollings Act of 1985 stipulated a six-year schedule of declining deficit ceilings, culminating in a balanced budget in 1991. Congress never kept deficits under those statutory ceilings.
Federal tax revenues and spending are impacted automatically when the economy grows or contracts. In 1990, Congress amended Gramm-Rudman-Hollings to focus on spending caps rather than deficits. Limits were set on discretionary spending for future years. Those caps were routinely ignored.
The Budget Enforcement Act of 1990 also introduced the “pay-as-you-go” budget constraint, which requires Congress to offset any spending or tax cuts with matching outlay cuts or tax hikes. This constraint is a convenient argument for both political parties to resist budget initiatives of the other party and can be set aside at Congress‘ whim.
In 1985, Congress established sequestration. If Congress breached its own statutory deficit ceilings or spending caps, the budget would be subjected to automatic spending cuts. Sequestration impacts defense and other discretionary programs, as virtually all mandatory outlays such as Social Security are exempted. From 1986 to 1991, five sequestrations were triggered; all but one (1986) were rescinded. That one briefly cut $11.7 billion out of the defense and non-defense discretionary programs. This time, the expected sequestration is more than $1 trillion.
Another mechanism of budget enforcement is the debt ceiling. Persistent budget deficits keep pushing the debt against that limit, which means Congress either must raise the debt ceiling or shut down the government. It always raises the debt ceiling. It has done so 77 times since 1962.
The ultimate budget enforcement mechanism is a constitutional amendment that forbids deficit spending. Economists warn that such a budget straitjacket is unenforceable and potentially disastrous. Still, it has enormous popular appeal. If two-thirds majorities of both chambers pass it, it goes to the states for ratification with a three-fourths majority. In 1995, a balanced-budget amendment passed the House and came within a single vote of passing the Senate. Then there is the state route. Thirty-four states can force Congress to call a constitutional convention. Thirty-two states have passed that provision.
The public is fed up with soaring debt and Congress‘ inability to exercise fiscal restraint. People have near-zero confidence in Congress, which spills over into their perceptions of the economy. They see runaway deficits, soaring debt and a complete lack of fiscal leadership. These perceptions restrain investment spending, deter consumer purchases, constrain bank lending and slow foreign investment. The end result is slower economic growth and persistently high unemployment.
When economists such as Paul Krugman claim that the United States still can afford larger deficits and debt, they fail to understand the psychology of market participants and the consequences for market behavior. The markets are saying, “Enough is enough.”
Brad Schiller is emeritus professor of economics at the American University.