WASHINGTON — The debt ceiling is a legal cap on the amount of money the U.S. Treasury can borrow to fund existing government functions. It essentially authorizes the Treasury to borrow the money necessary to pay the bills incurred by the federal government.
Where it came from: Before 1917, Congress authorized the Treasury to issue bonds for specific purposes. But that meant approving every bond separately. To fund World War I, Congress decided to give the Treasury more latitude by instituting caps on how much it could borrow through each type of bond, rather than forcing it to get every new bond approved separately. In 1939, this was changed so that most bonds were bound by the same limit, effectively creating the general debt ceiling we have today.
How it has worked: The debt ceiling has traditionally been raised as a matter of course whenever Congress passes spending bills requiring more borrowing, though the opposition party has often voted against increases to signal its opposition to the majority’s deficit spending. Between 1940 and 2010, we have increased the debt limit more than 70 times, and from 1979 to 1995, a House rule proposed by Rep. Dick Gephardt made increases automatic by raising the ceiling whenever new spending is approved. The new Republican majority repealed this rule in 1995 to use raising the debt ceiling as leverage in getting President Clinton to agree to spending cuts.
Why it’s an issue now: Currently, the debt limit is set at $14.3 trillion. Around Aug. 2, the Treasury will exhaust that borrowing authority. Because spending currently exceeds revenues by almost 45 percent, if that happens, we will either have to default on our debt or stop funding a substantial portion of the government. Congress could simply choose to raise the debt ceiling, but like the 1995 House GOP, the 2011 House GOP is insisting that it will not increase the debt ceiling without large spending cuts from President Obama.
What happens if we don’t raise the debt ceiling but continue to pay interest on bonds?: This is an option known as “prioritization.” The Bipartisan Policy Center released a report attempting to think through how this would work in practice, as it has never been attempted before. The raw numbers are chilling: In August, the federal government would have to cut expenditures by about $134 billion, or 10 percent of the month’s GDP. If it chose, for instance, to fund Medicare, Medicaid, Social Security, supplies for the troops and interest on our bonds, it would have to stop funding every other part of the federal government. The drop in demand, when coupled with the turmoil in the markets and the general financial uncertainty, would undoubtedly throw the economy back into a recession. Also keep in mind that we have to roll over $500 billion in debt that month, and if there was uncertainty about how we were going to pay our bills, it is not clear we could find buyers for our debt at anything less than an exorbitant rate. In this way, “prioritization” could increase the deficit.
What happens if we stop paying the interest on our debt?: This is too scary to consider for any serious length of time. Treasury securities sit at the base of the global financial system. They are considered so safe that the interest rate on Treasuries is called the “riskless rate of return,” as the market assumes there is no chance of default under any circumstances. Almost all other types of debt — mortgages, credit card, auto loans, business loans, hospital bonds, etc. — are yoked to Treasuries. Almost all major financial players hold substantial portfolios of Treasuries or Treasury-related debt to buffer themselves against financial shocks. Consider that the 2007 financial crisis was caused by the market realizing it had to reassess the risk of bonds based on subprime mortgages. If the market has to reassess the risk of Treasuries, the resulting financial crisis will be beyond anything we’ve ever seen in this country.
Do we need a debt ceiling?: Strictly speaking, no. The debt ceiling is unique to America. In other countries, when the legislature passes a law, the Treasury is given automatic authority to carry it out. A number of former Treasury secretaries have said it should be abolished, including Larry Summers, who said, “I think that given that Congress has to approve all spending and all tax changes, there is not much logic to the debt ceiling.”
Does the debt ceiling reduce deficits?: In general, no. The nonpartisan Congressional Budget Office examined this issue and concluded that “setting a limit on the debt is an ineffective means of controlling deficits because the decisions that necessitate borrowing are made through other legislative actions. By the time an increase in the debt ceiling comes up for approval, it is too lat e to avoid paying the government’s pending bills without incurring serious negative consequences.”
Is the debt ceiling unconstitutional?: A number of commentators have suggested that the 14th Amendment, which states that “the validity of the public debt of the United States … shall not be questioned,” renders the debt ceiling unconstitutional. Others have disagreed, including Lawrence Tribe, a professor of constitutional law at Harvard, who notes that the Constitution gives Congress the sole power “to borrow money on the credit of the United States.” Ultimately, this point is probably moot, at least for the time being, as Treasury has stated that it agrees with Tribe’s interpretation.