The United States is facing yet another debt limit crisis that could potentially have severe consequences for the economy and the banking sector. According to economists, falling tax revenues, especially from federal investment taxes and corporate tax receipts, could lead to a cash shortfall that may prevent the Treasury from making payments on time.
Goldman Sachs has warned that the US could run out of cash sooner than expected, with the odds of a June deadline increasing as non-withheld income tax receipts decline. This could potentially lead to a default on US debt payments, as the Treasury would not have sufficient funds to cover its obligations. The consequences of a debt limit crisis could be catastrophic, affecting not just the US economy but also global financial markets.
In this article, we will explore the causes and consequences of the US debt limit crisis, and possible solutions to avoid a default.
Causes of the US Debt Limit Crisis
The US debt limit crisis has been a recurring issue for decades, with politicians from both parties using it as a bargaining chip to gain leverage on other issues. The debt limit is a statutory limit on the amount of debt that the US government can issue. The current debt limit is set at $28.4 trillion, and the Treasury is set to exhaust its borrowing authority in the coming weeks if Congress does not act to raise or suspend the debt limit.
The primary cause of the current debt limit crisis is falling tax revenues, which have been hit hard by the COVID-19 pandemic. According to Garrett Watson, a senior policy analyst and modelling manager at the Tax Foundation, a decline in capital gains realisations, profits made from financial investments taxed by the federal government, and a decline in corporate tax receipts could contribute to falling tax revenues.
The pandemic has also resulted in a decline in economic activity, which has further reduced tax revenues. According to the Congressional Budget Office, the federal budget deficit in 2020 was $3.1 trillion, the largest deficit as a share of GDP since World War II.
The consequences of the US Debt Limit Crisis
The consequences of the US debt limit crisis could be dire, affecting not just the US economy but also global financial markets. A default on US debt payments could lead to a loss of confidence in the US dollar, which is the world’s reserve currency, and could trigger a global recession.
A default would also have severe consequences for the banking sector, which holds a large amount of US government debt. Banks use US Treasuries as collateral for loans, and a default could lead to a collapse of the financial system.
The debt limit crisis could also lead to a government shutdown, as the Treasury would not have sufficient funds to pay for government operations. During the 2013 government shutdown, which lasted for 16 days, 800,000 federal employees were furloughed, and many government services were disrupted.
Possible Solutions
The most obvious solution to avoid a debt limit crisis is for Congress to raise or suspend the debt limit. However, this has become a highly politicized issue, with Republicans and Democrats taking partisan positions.
In recent weeks, top Senate Democrats have revived the idea of using the budget reconciliation process to raise or suspend the debt limit, which would require only a simple majority vote in the Senate. However, this would require significant political will and may face opposition from Republicans.
Another possible solution is for the Treasury to prioritize its payments, focusing on essential services such as Social Security and Medicare, and delaying payments to other government agencies. However, this would only be a short-term solution and could lead to a government shutdown.
Conclusion
The US debt limit crisis is a grave threat to the global financial system and needs to be addressed urgently. Falling tax revenues, primarily due to the COVID-19 pandemic, have led to a cash shortfall that could prevent the Treasury from making payments on time. A default on US debt payments would have severe consequences for the economy and the banking sector, and could trigger a global recession.
Possible solutions include raising or suspending the debt limit, using the budget reconciliation process, or prioritizing payments. However, these solutions require significant political will and may face opposition from the opposing party. The sooner politicians take action, the better, to prevent a default and avoid the catastrophic consequences of a debt limit crisis.
