Steven Pressman, Monmouth University
Republicans and Democrats are once again fighting a battle of wills over America’s debt ceiling, which is a legal limit on how much the government can borrow to pay its bills. Senate Minority Leader Mitch McConnell has said no member of his party will support a bill raising or suspending the debt limit – even though he says he wants to see it increased – and Democrats hesitate to do it themselves. For now, Democrats are hoping to do so as part of a must-see spending bill.
Congress suspended the debt ceiling in 2019 for two years, until July 31, 2021. Since then, the US Treasury Department has taken emergency measures allowing it to continue borrowing without increasing the limit. Treasury Secretary Janet Yellen said those options would run out in October and if the United States did not allow more borrowing, it would face a “catastrophe” – drastic cuts in general spending. , or the prospect of an unprecedented default.
Economist Steve Pressman explains why we have a cap – and why he thinks it’s time to scrap it.
1. What is the debt ceiling?
Like the rest of us, governments need to borrow when they spend more money than they receive. They do this by issuing bonds, which are basically IOUs with a promise to repay the money and pay regular interest. Public debt is the sum total of all this borrowed money.
The debt ceiling, which Congress established a century ago, is the maximum amount the government can borrow. It is a limit on the national debt.
2. What is the national debt?
Currently, the US government debt is just under $ 28.5 trillion, about 29% more than the value of all goods and services that will be produced in the US economy this year.
About a quarter of that money the government actually owes. The Social Security Administration has built up a surplus and is investing the extra money, currently $ 2.9 trillion, in government bonds. The Federal Reserve holds more than $ 5,000 billion in US Treasuries.
The rest is public debt. As of May 2021, foreign countries, businesses and individuals held $ 7.5 trillion in US public debt. Japan and China are the biggest holders, with more than $ 1,000 billion each. The remainder is owed to US citizens and businesses, as well as state and local governments.
3. Why is there a borrowing limit?
Prior to 1917, Congress allowed the government to borrow a fixed amount of money for a fixed term. When the loans were repaid, the government could no longer borrow unless it was authorized to do so.
The Second Liberty Bond Act of 1917, which created the debt ceiling, changed that. It allowed a continuous rollover of debt without congressional approval.
Congress passed the move to allow then-President Woodrow Wilson to spend the money he deemed necessary to fight World War I without waiting for often absent lawmakers to act. Congress, however, was unwilling to give the president a blank check, so it limited borrowing to $ 11.5 billion and demanded legislation for any increases.
The debt ceiling has been raised dozens of times since and suspended several times. The last change was in August 2019, when Congress suspended the limit until July 31, 2021.
The new cap, which took effect on August 1, will become the outstanding debt at the end of July 31 – $ 28.4 trillion.
4. What happens when the United States hits the cap?
The US government typically spends more than it earns – an additional $ 3.1 trillion in fiscal 2020. Once it hits the debt limit, it is no longer possible to borrow for make up the difference. The government can only spend its cash and tax revenues.
Yellen will then have to use “extraordinary measures” to save money. One of these measures is to temporarily not fund government employee retirement programs. It is expected that once the cap is raised, the government will make up the difference.
In Yellen’s favor, the Treasury had about $ 450 billion in liquidity at the end of July, which probably lasted about a month. In September, estimated tax payments from businesses and individuals will go to the treasury. Things then get complicated in October.
If the debt ceiling is not raised before the Treasury exhausts its options, decisions will have to be made as to who will be paid with the daily tax receipts. Government employees or contractors may not be paid in full. Small business or student loans may stop.
When the government cannot pay all of its bills, it is technically in default. Some experts have argued that a government default would have dire economic consequences – soaring interest rates, panicking markets and possibly economic depression.
Such fears seem exaggerated, mainly because once the markets start to panic, Congress and the President generally act. This is exactly what happened in 2013 when Republicans sought to use the debt ceiling to fund the Affordable Care Act.
But Americans no longer live in normal political times. The major political parties are more polarized than ever.
5. Is there a better way?
The United States is one of the few countries that has a debt ceiling. Other governments function effectively without it. America could too.
In my opinion, having a debt ceiling is dysfunctional. This makes it more difficult for the treasury to pay the bills as they fall due.
The best solution would be to remove the cap altogether. Congress has already approved spending and tax laws that require more debt; nor should he have to approve the additional borrowing.
It must be remembered that the original debt ceiling was put in place because Congress could not quickly come together and approve the expenses necessary to wage a war. In 1917, trips across the country were made by train, which took days to get to Washington. It made sense then. Today, when Congress can vote online from home, not at all.
This is an updated version of an article originally published on July 18, 2019.
Steven Pressman, Emeritus Professor of Economics and Finance, Monmouth University
This article is republished from The Conversation under a Creative Commons license. Read the original article.