With the United States expected to reach the “debt ceiling”, the legal limit of federal borrowing, this spring, Republican Pat Toomey, R-PA, has proposed a measure requiring payments to bondholders take precedence over all other federal spending. Toomey wrote a piece in the Wall Street journal explaining the rationale behind his proposal, but critics are saying it would place foreign lenders ahead of veterans and social security recipients. While this is technically correct, Senator Toomey’s proposal has merit and bears serious consideration.
Toomey offered the proposal in the form of an amendment to a bill reauthorizing the Federal Aviation Administration. The language of the measure states that “The principal and interest on debt held by the public shall take priority over all other obligations incurred by the government of the United States”. Critics immediately labeled the amendment the “Pay China First Act”. When one considers recent cables released by Wikileaks detailing efforts by the Chinese to use our debt as leverage to influence foreign and domestic policy, paying China first may be a good idea.
Daniel J. Mitchell of the libertarian leaning CATO institute has written that the interest on the debt amounts to $200 billion while the Treasury will take in about $2.1 trillion this year. His point is that there is plenty of money to pay bondholders and still meet our commitments to veterans, the poor and the aged. He further writes that this bill would have the effect of reassuring our creditors and preventing a sovereign debt crisis akin to Greece. The primary effect of this measure, were it adopted, would be to force consideration of real spending cuts in the federal budget while providing a powerful tool to deficit hawks.
No one is certain what would happen if the United States were to reach the debt ceiling. Some have suggested it would result in a massive default on the federal debt. This worst case scenario would cause our credit rating to be downgraded, which Moody’s has already suggested might happen anyway. At that point we could expect massive spikes in interest rates with all the associated detrimental economic effects. However, if Mr. Mitchell’s analysis is correct, there is no reason the United States cannot pay our debt to China and still keep promises made to veterans and retirees.
In effect Senator Toomey’s proposal seeks to reassure the markets that the United States will not default on its debt. Were this measure to be adopted the United States would pay our creditors first and then pay our remaining obligations, both necessary and discretionary, with the remaining balance of funds. This is how households across the country have always had to behave. Supporters of Mr. Toomey’s proposal believe that forcing the government to prioritize obligations in this way would drive home the real costs of the borrowing that has taken place under both parties for far too long.