What is the Debt Ceiling and Why Does it Matter?
October 15, 2013
On October 17th, the government will reach the debt ceiling if Congress does not pass legislation to raise its borrowing limit. As opposed to the government shutdown, which has not had much impact on the economy outside of Washington D.C., breaching the debt ceiling could be a lot worse.
What is the Debt Ceiling?
The debt ceiling is a legally binding limit on the amount of national debt that can be issued by the treasury. Currently, the limit is set at $16.699 trillion. The debt ceiling was first created in 1917 as a part of the 2nd Liberty Bond Act.
Does the Debt Ceiling have Anything to Do with the Government Shutdown?
Although these two events are happening near one another, they are not related.
The government shutdown is a result of the fact that Congress was unable to pass a budget to fund the government. According to the Constitution, Congress must pass a budget. Otherwise, when the fiscal year ends, the government can no longer stay open. (Of course, most of the government still operates since its funding is independent from the budget process).
The debt ceiling is set independently in separate legislation and dictates not how much the government can spend, but how much it can borrow.
Interestingly they do slightly interact with one another. Since the government shutdown stops payment for certain activities in the government, it marginally lowers the amount the government needs to borrow. However, this really doesn’t make much of a difference. According to the Washington Post, the government will still exhaust its cash balance by the end of October even with a shutdown due to the fact the government still needs to spend billions on mandatory benefit payments.
What Happens When We Reach the Ceiling?
Once the U.S. government reaches the debt limit, it can no longer take on any more debt. In other words, it will be left with the cash it has on hand.
According to analysis by the Bipartisan Policy Center, the month after the government breaches the debt ceiling treasury will collect $222 billion. However, it will owe $328 billion.
This means that the government will no longer be able to pay all of its bills and may not be able to pay the interest on its debt and could default.
What would a Default mean for the Economy?
As opposed to the government shutdown, which won’t have much effect on the economy, a default on the debt would definitely affect the economy.
Currently, there are about $16.7 trillion of outstanding U.S. bonds. Those who hold the treasuries would risk not getting paid. This could drive up the cost of borrowing money, reduce the value of many investments, and greatly slow down the economy.
In addition, most of the bonds are owned by the Social Security Trust fund. If the government cannot pay interest on the debt it owes itself, Social Security may not be able to pay all of its benefits.
Can we Avoid Defaulting without Raising the Debt Ceiling?
This is what a lot of the current debate on the debt ceiling is over. While the Obama administration claims that reaching the debt limit will mean default, some Republicans are saying there are ways to prevent a default even if the government reaches the ceiling.
Specifically, politicians are arguing over whether the treasury can prioritize its payments. This means that the treasury can pick and choose which payments to make when the money comes in. For instance, of the $222 billion that the treasury receives in a month, it could choose to pay all of the interest payments that come due and ignore other payments. This would lessen the impact of breaching the debt ceiling.
However, some have pointed out that this may not even be legal or feasible. According to Treasury officials the U.S. government payment system is so complex it may not be possible to pick and choose which bills to pay in time to prevent a default. Even if it were possible, it may not be legal. According to a Bipartisan Policy Center Expert in the Washington Post, “Anyone who says they know whether this is legal is not telling the truth.”
How about using “Extraordinary Measures?”
Currently Treasury has been employing what are called “extraordinary measures” since May of this year in order to pay the government’s bills. Simply, these are ways the government can raise extra money if it can no longer borrow.
These measures include suspending investments of the “Thrift Savings Plan G Fund” and other funds, suspend issuances of new securities to the Civil Service Retirement and Disability Fund, and suspend the issuance of new State and Local Government securities.
The Treasury has actually been using these measures since May when we officially hit the debt ceiling. October 17th actually marks the day on which these measures are exhausted.
How many Times Has the Government Raised the Debt Ceiling?
This is not the first time the debt ceiling has been raised. In fact, the debt ceiling has been raised 74 times since March of 1962.
Chart from Cato
Has the Government Ever Defaulted on its Debt?
Although the talking point coming out of the Obama administration is that the government has always made its payments, the U.S. government has defaulted before.
According to a Politico article, there were two defaults in American history. One following the War of 1812 when the government could not pay its bill on account of the fact that D.C. was burned to the ground. The second time in 1979 when there was a “glitch” at Treasury that delayed payment to bond holders.
As a result of the most recent default, interest rates on treasury bills spiked 0.6 percent, leading to an increased borrowing cost for the U.S. government of about $12 billion.