There is, however, a fairly straightforward way that the U.S. could, in theory, default. Since the federal budget runs at a deficit, we need to keep borrowing money to pay our bills. This means that we have to increase our absolute debt level, and there's a legal limit -- the debt ceiling. Once the debt hits that level we can't borrow more unless Congress passes legislation to increase the ceiling.
What would this mean? In simple terms, the U.S. wouldn't be able to pay its bills and we would default on a number of obligations, including our debt obligations. Even if resolved quickly this would likely attach a significant risk premium to our government borrowings which would do serious damage to our economy and make the budget deficit worse.
So far Congress has always increased the debt ceiling as needed but recent years have seen an occasional game of chicken being played, with politicians threatening to vote against an increase unless certain demands are met. Most recently, some members of the Tea Party have demanded major cuts in spending in exchange for allowing the ceiling to rise. Although the "grownups" of each party have kept these revolts from getting serious, the specter of a debt default is scary enough to have attracted efforts to prevent it in a more structural way.
Pat Toomey (R-Pennsylvania) has proposed an interesting way to reduce the damage that would be done by a failure to raise the debt ceiling. He has put forward legislation that would prioritize debt service payments in the event that the debt ceiling was not increased. As Toomey points out, tax revenues are more than sufficient to pay our debt service obligations provided only that they are prioritized under law and this would reduce the damage done by a failure to increase the ceiling. Think of it as changing a game of chicken from being played in airplanes (with each pilot having all their loved ones on board) to being played in cars -- maybe even cars that are only going ten or fifteen miles an hour, with the drivers wearing their seat belts and having air bags.
The bill has fifteen co-sponsors in the Senate -- all Republican. Democrats have attacked it on a number of fronts. Why is this a partisan issue?
Of course there are political reasons for Democrats to attack any Republican proposal (and vice versa). Accusing Republicans of putting the financial class ahead of social security recipients or putting China first grabs headlines and can be seen as part of the understandable (although unfortunate) attempts each party makes to delegitimize the other in the eyes of the electorate. It's also quite possible that there are legitimate disagreements over whether bondholders should be the top priority among government obligations in the event that the debt ceiling weren't increased. But let's assume for the moment that these factors aren't in play. Specifically, let's assume that there's broad support for Toomey's logic -- failure to meet our obligations to bondholders, even for a matter of hours or days, would be catastrophic. The Full Faith and Credit act would therefore seem like a reasonable way to reduce the risk of a catastrophe. Why then might Democrats still oppose it?
Remember the concept of BATNA -- a party's best alternative to negotiated agreement. Whenever our national debt approaches the ceiling, a negotiation takes place but it's a negotiation in which the BATNA is catastrophe. Republicans will demand spending cuts, tax cuts or specific reforms and will saber-rattle about blocking an increase in the debt ceiling but that's not really a credible threat because it would be a disaster, both for the nation and for the party that caused the default.
Toomey's plan changes that. The game of chicken is now being played in slow-moving cars rather than airplanes and the Republican threat not to increase the debt ceiling becomes a lot more credible. The Republican BATNA would be improved substantially so their demands become much harder for Democrats to resist.
Toomey and his co-sponsors know this, of course. In fact, Toomey gives away that half of the plan in the op-ed that introduced the plan:
If we do not raise it, the government's tax revenue will enable us to fund roughly two-thirds of projected expenditures, including interest payments. Without the ability to borrow the other third, spending cuts would be sudden and severe: Projects would be postponed, some vendor payments would be delayed, certain programs would be suspended, and many government employees might be furloughed. Default would easily be avoided, but these cuts would certainly be disruptive. That's why I hope we can avoid this scenario.
But it would be even worse simply to raise the debt ceiling without regaining control of federal spending. The recent surge in spending, both in absolute dollars and as a percentage of our GDP, has driven us to record deficits and an explosion of debt. The growth in discretionary spending has been the most dramatic, but in the future mandatory entitlement spending will be the deficit driver. Congress must address both in order to put the government back on a sustainable fiscal path.
The vote on whether to raise the debt ceiling—and, if so, by how much—is our best opportunity to insist that any increase in our nation's debt be coupled with concrete steps toward fiscal sanity. Congress should make increasing our debt contingent on immediate cuts in spending and effective reforms of the spending process that helped get us into this mess.While Toomey "hopes" Congress could avoid failure to agree on an increase to the debt ceiling, he makes clear both that such failure would be acceptable (assuming his bill is enacted into law) and would be superior to any agreement that didn't include clear measures to reduce spending. In negotiation terms, his plan would shift the negotiation from one in which neither party has an acceptable BATNA (and thus attempts to capture value are both risky and likely ineffective) to one in which only the Democrats would find failure to make a deal unacceptable.
That's a pretty attractive prospect for Republicans; small wonder they're the only ones who support the plan.
Toomey's plan is a great example of a broader strategic concept. Your BATNA is rarely static and you can often improve your negotiating position simply by improving your BATNA (or by worsening the BATNA of the other party or parties). If you're asking for a raise or promotion at work you're better off if you have an attractive offer from another firm than if your BATNA is simply to quit or start looking. If you're negotiating with a potential buyer for your house you're better off if you already have a solid offer from someone else. An improved BATNA makes it easier for you to walk away which, in turn, makes it much harder for those you're negotiating with to take a hard line against your interests.