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If Budget Talks Fail, U.S. Does Not Have to Default on National Debt

If Budget Talks Fail, U.S. Does Not Have to Default on National Debt

By Peter Morici - June 28, 2011

In the debt ceiling talks, President Obama and Republican leaders are locked in a battle of will. The simply truth is higher taxes are not needed, and the U.S. does not have to default if no deal is struck by August 2.

Democrats endlessly nag the $1.6 billion 2011 deficit is caused by profligate spending and tax cuts during the Bush years, and without tax increases the U.S. government faces default on the national debt.

Prairie Muffins!

In 2007, the last year before the financial crisis and Democrats Congress's first budget, with two wars ragging, the Bush tax cuts, and the prescription drug benefits for seniors, the federal deficit was only $161 billion.

In 2011, in the third year of economic recovery, the deficit is up ten-fold. The difference is $1.1 trillion in new spending--$200 to accommodate inflation and $900 in permanent spending increases put in place in guise of temporary stimulus by Democrats. That includes greatly enhanced Medicaid eligibility, an explosion in regulation that is failing to boost U.S. energy production and curb Wall Street abuses, and industrial policies that were supposed to create millions of new jobs.

The balance of the increase is mostly temporary tax breaks like the partial holiday in social security taxes and incentives for business to invest in new equipment scheduled to phase out.

The country doesn't need more taxes, it needs for the President and remaining Democrats in Congress to fess up and accept cuts in spending the nation can't afford.

Prior to the financial crisis, GDP grew about 2.9 percent a year, and now it is creeping along at closer to 2 percent. It doesn't take rocket science to see that jumping federal spending from 19.6 percent of to close to 26 percent in 2011 is not a pro-growth strategy.

The Democrats want higher taxes on the wealthy and plugging some corporate tax loopholes but that simply won't do it. The president's budget already assumes repeal of the Bush tax cuts for those earning over $250,000. Even raising income taxes by 50 percent on all families earning more than $200,000 would not yield much more than $250 billion a year. The resulting capital flight would reduce taxable income, and job losses would drive up federal social spending-net deficit reduction would not be large.

Although some loopholes could be plugged, moderate Democrats and Republicans agree U.S. corporate taxes are too high for American companies to be competitive. Most revenue that might be found fixing abuses will eventually have to be put into lower corporate taxes for those firms bearing more than their fair share of the burden.

If budget negotiators can't focus on those facts before August, the U.S. government is facing a shutdown-something it has endured in the past-but it does not have to default on the national debt.

Default is a reckless threat.

The U.S. government will still be collecting taxes equaling about 55 percent of expenses-and interest on the debt could easily be paid; social security and Medicare checks could go out, and the military adequately funded. Other functions would have to be greatly scaled back. This has been endured before and is not pretty, but make no mistake about it, we have plenty of money on hand to pay $18 billion each month in interest on the debt. With a sound plan to manage the crisis, bonds coming due could be rolled over.

Secretary Geithner, whose primary skills are bureaucratic and not economic, appears intent on forcing a crisis rather than making plans to keep the country going. That would likely include phasing down some operations the last weeks of July as the early August deadline draws closer.

That would take away the President and Democratic leaders club in the debt-ceiling negotiations, and their strategy to continually paint Republicans as spendthrifts.

Sadly, the Republicans as inept as ever, don't have the sense to debunk Democratic rhetoric with hard facts.

Leadership failure by both parties-an inability to face facts-is why the U.S. government is facing default.

Avoiding default does not require more taxes, and default doesn't have to happen if Democrats won't accept a deal without higher taxes.

Morici is an economist and professor at the University of Maryland Robert H. Smith School of Business. Follow him on Twitter, @pmorici1.

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