The government shutdown is already causing severe hardship across the country, but we are quickly approaching an even larger crisis: breaching the federal debt limit. Experts at the U.S. Department of the Treasury warn that if Congress fails to raise the debt limit soon, the result could be an economic catastrophe “of the magnitude of late 2008 or worse, and the result then was a recession more severe than any seen since the Great Depression.”
This column will answer the five most important questions for understanding the debt limit crisis:
- What is the debt limit?
- What happens if we don’t raise the debt limit?
- Does raising the debt limit authorize new spending?
- Is there an alternative to raising the debt limit?
- Who is responsible for raising the debt limit?
What is the debt limit?
The debt limit is the legal maximum that the federal government is allowed to borrow. When Congress spends more than it collects in taxes, the federal government runs a deficit. The Treasury Department borrows money to cover that deficit by selling bonds, enabling the government to carry out the legislation passed by Congress. The Treasury Department is not allowed to borrow more than the debt limit, which is currently set just below $16.7 trillion.
As the national debt has increased under Republican and Democratic Congresses and administrations, both parties have always raised the debt limit when necessary. That’s because if the Treasury Department needs to borrow more than the debt limit allows, then the United States cannot pay its bills. That means the United States would be in default, which could mean failing to pay bondholders, troops, Social Security recipients, or anyone else to whom the government legally owes money.
What happens if we don’t raise the debt limit?
Because the debt ceiling has always been raised in time to avoid default, no one knows for sure. The debt ceiling was officially reached back in May, and since then the Treasury Department has utilized “extraordinary measures” to shift funds as necessary to avoid a default. But the Treasury Department reports that it will exhaust those extraordinary measures on October 17, 2013, which is just days away.
Starting October 17, the Treasury Department expects that it will only be able to pay the government’s daily bills with whatever revenue happens to come in that day. The Bipartisan Policy Center estimates that at some point between October 22 and November 1, the Treasury Department will not have enough revenue to pay the bills, and the United States will default on its obligations.
A default could cause a financial panic similar to the 2008 financial crisis, if not worse. In 2008, investors assumed that mortgages were less risky than they really were. Treasury bonds are considered a risk-free investment, but a default would quickly change that. The assumption that Treasury bonds are risk-free is so foundational that many financial markets are based on Treasury bonds, using them to set interest rates or as safe collateral for loans. If Treasury bonds went into default—or even if investors grew concerned that they might—the effects would quickly ripple to everything from mortgage rates to auto loans to the stock market and many other financial products that millions of Americans and billions of others all over the world rely on.
Treasury bonds are just the tip of the iceberg if the debt limit is breached. The Treasury Department warns, “In the event that a debt limit impasse were to lead to a default, it could have a catastrophic effect on not just financial markets but also on job creation, consumer spending and economic growth.” That’s because breaching the debt limit would force the Treasury Department to unilaterally balance the budget overnight. That would cause a massive negative shock to our economy, as federal spending would immediately drop by 32 percent. That means Social Security checks might not go out. Businesses that sell goods and services to the government might not get paid. The social safety net could disappear overnight for Americans already living paycheck to paycheck. According to Goldman Sachs, this sudden and severe austerity could reduce economic growth by more than 4 percent—enough to cause a “rapid downturn in economic activity if not reversed very quickly.”
As the analysts at RBC Capital Markets put it, “Let us be perfectly clear: crossing the debt ceiling would be catastrophic.”
Does raising the debt limit authorize new spending?
No. The debt limit does not set spending or tax policy. Congress and the president make those decisions. In fact, the United States is one of the only countries in the world with a separate debt limit. The debt limit simply determines whether the United States will honor the commitments it has already made. Even if Congress refuses to raise the debt limit, its obligations do not go away.
Is there an alternative to raising the debt limit?
No. Balancing the budget overnight is not realistic, and it would throw the economy into chaos. Troops expect to be paid and equipped to do their job. Bondholders expect to be paid. Millions of Americans rely on Social Security, Medicare, Medicaid, and other safety net programs to survive. Veterans deserve to earn the benefits they were promised. The Treasury Department could not pay for all of that, even if we stopped funding every other federal program—meaning no education, research, transportation, law enforcement, and public safety.
Even if Congress wanted to prioritize some categories of spending over others, the Treasury Department might be unable to do so. The Treasury Department processes millions of payments every day. Its systems are designed to process those payments as efficiently as possible, not to decide which bills to pay and which to ignore. The Treasury Department may be able to continue payments to bondholders, which are made using a separate system, but this would still be fraught with uncertainty and do nothing for everyone else legally owed money by the government.
Even if the technical barriers with the Treasury Department’s systems could be overcome, it would still be impossible to know which bills could be paid on any given day. Remember, the Treasury Department would have to operate with only the cash it happens to have on hand. Daily revenue is highly volatile, meaning that the Treasury Department does not know how much money it will have from one day to the next. Additionally, government spending rises and falls depending on what payments need to be made each day. It would not take long before the Treasury Department hit a day where it could not make even the highest priority payments.
Who is responsible for raising the debt limit?
Congress has to pass legislation to raise the debt limit, which President Barack Obama would sign into law. Congress has always raised the debt limit whenever necessary to avoid default. The debt limit was raised under Presidents Jimmy Carter, Ronald Reagan, George H.W. Bush, Bill Clinton, George W. Bush, and Barack Obama.
Both Republicans and Democrats, in Congress and the White House, have agreed to the tax and spending decisions that increased the national debt in the past. Most recently, in January, Republicans in the House of Representatives, Democrats in the Senate, and President Obama all agreed to raise the national debt by more than $3 trillion in the next 10 years, by extending the bulk of the tax cuts first signed into law by President George W. Bush in 2001 and 2003.
Raising the debt limit is not a victory for anyone, nor is it a concession that one side has to make to the other. Raising the debt limit is a simple acknowledgement that the United States must pay its bills and stay true to its word.
Harry Stein is the Associate Director for Fiscal Policy at the Center for American Progress.
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Director, Fiscal Policy