Debt ceiling: If $4 trillion 'grand bargain' fails, is America in trouble?

Debt ceiling talks could result in a $4 trillion 'grand bargain,' or a smaller $2 trillion deal. Most economist say the bigger deal would be more helpful – and send a positive message to markets.

Talks over how to tame runaway federal borrowing have bounced back and forth between two general targets: a "grand bargain" $4 trillion in deficit reduction and a smaller deal for perhaps $2 trillion.

President Obama insisted Monday that he's eager to push for the larger target, if Republicans would just consider boosting tax revenue as well as cutting spending cut to get the job done. House Speaker John Boehner said over the weekend that the politics of the moment favor a smaller plan.

In either case future federal deficits would be smaller, by those projected amounts, over the next decade.

So would it be bad for the economy if the debt talks can't hit the higher target?

Finance experts don't come down uniformly on one side of the question, but many say it would be better to reach the large goal than the small one.

"This country needs a deal to achieve $4 [trillion] to $5 trillion in deficit reduction, and we need to put such a deal in place as quickly as possible,” Maya MacGuineas, president of the Committee for a Responsible Federal Budget, said in a recent statement on the debt negotiations.

The group she heads, in its nonpartisan analysis of the fiscal issues, argues that failing to take strong action could put the economy at risk. In its estimate, deficit reduction of less than $4 trillion won't be enough to stabilize the national debt as a share of the economy in coming years. (The $4 trillion target was also used by President Obama's bipartisan fiscal commission, among others.)

Fast-growing debt could slow economic growth and cause investors to demand higher interest when loaning money to the US Treasury.

Already, credit-rating agencies have warned that the US could face a credit downgrade (making it more expensive to borrow) within the next couple of years, if action isn't taken to improve the government's finances.

"Pushing this beyond the election [in 2012] is incredibly risky," Ms. MacGuineas said in a recent interview with the Monitor. If the politics between Democrats and Republicans are difficult now, she argues, the election might end up only hardening the battle lines.

So far, financial markets aren't showing any signs of panic about US creditworthiness. Treasury Secretary Timothy Geithner has warned, however, that if Congress doesn't raise the debt limit by Aug. 2, the government will be unable to pay all its bills. The current talks are aimed at raising that debt ceiling, paired with efforts to bring down future deficits.

Mr. Obama said both sides are determined not to let things get to the brink of a Treasury default.

A $2 trillion bargain, like a larger one, would avert the risk of an near-term default by the Treasury.

But it might mean that Obama and Congress have to bargain again over the debt limit before the next election.

Moreover, unless such a deal is paired with commitments by both parties to keep working for additional progress, the move might signal to investors that the US political system is broken. The problem: control of government is divided between two parties that can't find common ground on the core issues of entitlements and taxes.

To many Republicans, the bottom line in negotiations is that any deal should not raise new tax revenue.

Democrats, meanwhile, are holding the line against any reduction in entitlement benefits. If those positions don't budge, it becomes nearly impossible to reach the $4 trillion target (which would cut projected deficits nearly in half).

Even to reach the lesser target of $2 trillion, the two sides may need to bend from cherished positions. "I don't see a path to a deal if they don't budge," Obama said Monday, in a reference to congressional Republicans and in an effort to cast himself as centrist, coaxing left and right to keep bargaining.

But the two sides remain far apart on the tax issue, with Democrats arguing that "shared sacrifice" should include higher taxes paid by the richest Americans.

Obama called for a "balanced" deal involving some new tax money.

Speaker Boehner fired back Monday that "adding tax increases to the equation doesn't balance anything" for Americans beset by 9.2 percent unemployment. Boehner argued that Democratic policies would impose taxes on "the very people" who are being asked to create jobs.

Although a $4 trillion deal would be preferred by many budget experts, it's far from certain that a failure to reach that goal would result in a creditor revolt by 2012. Nor is it certain that firms like Moody's and Standard & Poor's would move to downgrade America that soon.

But most economists say that fiscal reforms are vital for the economy, and that ultimately they must including putting Social Security and Medicare on sustainable footing.

At the same time, as important as the debt talks are, economists say other policies to boost the job market are also needed.