Every now and then, the news cycle is consumed by talk of the debt ceiling and the crisis that the country is headed for if it's not raised. Read on to learn how the debt ceiling works and why it matters.
The U.S. government uses borrowed money to cover most of its expenses since revenues from taxes cover only a portion of ongoing costs. One of the roles of the U.S. Treasury Department is to issue securities in the form of bills, notes or bonds to borrow from investors. Because the level of federal borrowing affects the economy, there is a need to control the securities that the Treasury issues.
In 1917, Congress voted to establish a national debt ceiling that would act as a cap on how much the government can borrow. Over the next 100 years, Congress has regularly raised this debt ceiling so the government can keep borrowing more funds, turning the debt ceiling into a hotly debated issue that has repeatedly been at the heart of crises, government shutdowns and debates over federal spending.
Prior to 1917, the Treasury issued bonds to fund federal spending, but Congress had to authorize each new series of bonds by passing a law.
To simplify this process, Congress passed the Second Liberty Bond Act in 1917. This act introduced the concept of a statutory debt limit. The Treasury could keep issuing bonds until this limit was reached without having to obtain congressional approval. This act also limited the total amount of debt that could be incurred via the different instruments issued by the Treasury.
Further changes were made with the Public Debt Acts in 1939 and its amendment passed in 1941. Besides raising the debt limit, Congress agreed to aggregate debt into a single category rather than managing each Treasury-issued instrument separately.
Over the following years, Congress passed a number of Public Debt Acts to keep raising the debt ceiling. In 1979, the House adopted the Gephardt Rule, which tied raising the deficit ceiling to passing a new budget. This rule made increasing the debt limit easier and ensured that the government’s borrowing allowance matched the current budget. It remained in effect until 1995.
In more recent history, the 2018 and 2019 Bipartisan Budget Acts were adopted as part of a long series of measures to keep raising the debt ceiling. Congress is set to meet in December (2021) and negotiate the current U.S. debt ceiling to reflect increased federal spending as a result of the pandemic.
Raising the debt ceiling happens through acts passed via the traditional legislative process. Typically, a representative sponsors a proposal to raise the debt ceiling when the national debt gets close to the current limit. A House committee reviews this proposal before representatives vote on it. If the proposal gets a majority of votes in the House, it moves to the Senate. A second committee reviews the proposal, and then the senators vote on it.
If the proposal gets a majority in the House and the Senate, a committee with members of both institutions reviews it and makes changes if needed. The bill then goes back to the House and the Senate for a final vote. After it passes Congress, the president can sign or veto the bill.
The Treasury is in charge of implementing the debt ceiling by issuing bonds and other instruments to borrow money. This government agency is responsible for stopping borrowing when the ceiling is reached.
The debt ceiling becomes a trending news topic every once in a while. Representatives sometimes leverage this issue to draw attention to partisan politics or even sway public opinion during election years.
The following facts and myths will help you better understand the ongoing U.S. debt ceiling crisis and debt ceiling news.
A lot of what you hear about the debt ceiling isn't true, but we'll get to that later. First, here are some facts about the debt ceiling and its history:
There are also a few myths circulating about the debt ceiling. Let’s take a closer look at common misconceptions.
You’re probably familiar with the government shutdowns that happen when Congress can’t agree on raising the debt limit. These shutdowns get a lot of media attention, but there are other, more serious consequences if the national debt limit doesn’t go up.
Once the Treasury exhausts its extraordinary measures, payments to programs like Medicare and Social Security would have to stop. Eventually, the government would be unable to make good on its obligation to pay interest to investors who have purchased Treasury instruments and would default on its debt. Experts agree that defaulting on the federal debt would usher in a financial crisis of unprecedented scope.
The federal debt limit isn’t an allowance for money the government hasn’t spent yet. It’s a measure taken to cover costs the government has already incurred. You can think of it as balancing a budget at the end of the month and paying the bills that are due. However, continuously raising the debt ceiling sets a precedent and doesn’t encourage lawmakers to look for solutions to reduce the growing federal deficit.
Representatives have turned debates over the debt limit into a partisan issue in the past. A notorious example is the Republican-led House asking the Obama administration to defund the Affordable Care Act under threat of not raising the debt ceiling in 2013. The debt ceiling is a bipartisan issue since government spending is something that affects the future of the country.
In theory, having the Treasury prioritize payments sounds like a good solution to delay raising the spending ceiling. But in practice, determining which programs get money first is complex, and it’s unclear whether the Treasury has the authority to do so.
Failsafe mechanisms are in place to delay a default on the federal debt. The Treasury can take drastic measures to keep operating, and Congress has suspended the debt limit in recent history to buy more time.
The first effects would be felt through delayed payments to government programs and through government shutdowns. The U.S. would eventually default on its debt, but it would take time to reach that point.
Government spending has sharply increased over the past 100 years or so, as reflected by the rising debt ceiling. This overview of the history of the federal debt ceiling will give you a better idea of how sharp this increase has been.
In 2011, a Republican-controlled House asked the Obama administration to consider adopting measures to reduce the deficit that had sharply increased after the 2008 financial crisis. Financial markets were still volatile, and the national debt surpassed the GDP for the first time since WWII.
There were tensions over raising the debt ceiling, but Congress eventually adopted the Budget Control Act of 2011 and added $2.4 trillion to the debt limit. Congress agreed to a series of increases in 2011 and 2012, but federal spending reached the debt ceiling at the end of 2012. The Treasury had to take extraordinary measures, and Congress eventually suspended the debt limit until May 2013.
Instead of reaching an agreement in May 2013, Congress reset the debt limit and suspended it again until February 2014. This suspension was extended to March 2015, at which date Congress reset the limit again and elected to suspend it until March 2017.
Congress raised the debt limit a total of three times during the Trump administration. It also suspended the debt limit again until July 2021. Further, it passed legislation to temporarily increase it to $28.9 trillion and push back the default date to December 2021.
History shows that Congress has always raised or suspended the debt limit to avert sovereign default. However, reaching the debt ceiling could, in theory, lead to a government debt default.
The first thing that happens when the deficit ceiling is reached is that the Treasury stops selling securities. Next, the Treasury redeems existing investments and stops investing in retirement funds for government workers. It also stops putting money into the exchange stabilization fund, a reserve designed to purchase and sell foreign currencies and keep the exchange rate stable.
After taking these extraordinary measures, the Treasury can use cash on hand to pay for current obligations.
If Congress hasn’t raised or suspended the debt ceiling by this point, the Treasury stops paying interest to investors who have purchased securities. Payments to different funds and programs gradually stop as the Treasury runs out of cash, forcing the government to default on its obligations.
The X date of the debt limit is the tipping point where the Treasury would run out of extraordinary measures and cash on hand. It’s not the same as default, but it indicates that the government can't meet all its financial obligations on time.
Debt ceiling brinkmanship has become a prevalent practice in recent history. It's a growing disregard for potential consequences as both sides use the debt ceiling discussion to push partisan issues. The U.S. has a long history of approving increases in the debt limit, and representatives have become complacent. They assume an agreement will be reached and keep taking higher risks. The 2011 debt ceiling crisis and 2013 shutdown are prime examples of debt ceiling brinkmanship in which both parties kept delaying raising the debt ceiling and no true solution to curb federal spending was adopted in the end.
In the short term, this brinkmanship results in a series of crises or barely averted crises. Government shutdowns and extraordinary measures become commonplace. When repeated, these short-term crises damage confidence in the government, leading to volatility in financial markets. The country’s AAA credit rating could eventually suffer because of this practice.
Brinkmanship is a costly issue, too. It depletes the Treasury’s reserves of cash on hand, which makes this government agency less resilient in case of a disaster or other unforeseen event. There are also significant costs associated with adopting extraordinary measures.
The historical trend is that Congress keeps increasing the spending ceiling so the government can meet its obligations. It also promotes higher rates of government spending rather than challenging it. The climbing Treasury debt limit has several long-term effects.
Higher debt levels mean higher interest payments. These payments are currently one of the main spending categories for the U.S. government, and they could triple over the next decade.
Spending money on interest makes less funding available for things like social programs, research and infrastructure updates.
Issuing more Treasury securities can divert investment dollars from other vehicles. Repeated government shutdowns and averted crises also reduce confidence and lead to market volatility. In the long term, these repeated episodes can threaten the macroeconomic stability of the country and limit growth. High levels of debt also make borrowing ever more expensive, which makes it harder for the government to inject funds into the economy to stabilize or boost it when needed.
As government spending on interest payments keeps rising, taxes will likely increase in an effort to offset some of these costs. Higher taxes would combine with other issues, like stagnating wages, and result in a lower standard of living for a lot of people. High levels of federal debt also contribute to inflation, which can further reduce the standard of living.
Finally, the growing federal debt can result in high-interest rates, which would exacerbate issues like access to homeownership or the ability to pay off student debt.
Government leaders and lawmakers have mentioned a number of possible solutions to tackle the ongoing issue of the debt ceiling. Here are some of these proposals:
The debt ceiling is a necessary instrument for ensuring that the government can pay its bills and debts. However, brinkmanship has turned it into an ongoing issue that can threaten the country's political and economic stability while diverting attention from the more serious issue of growing federal spending, which increased further during COVID-19.
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