While all of Washington is abuzz about the fiscal cliff—the combination of tax hikes and spending cuts that will go into effect on Jan. 1—there’s another budget deadline waiting for us: the debt ceiling. Although we’re not likely to hit it for more than a month, it’s a looming threat to our economy that will only go into effect if the government does nothing about it. Here’s a guide to what it is and why it matters.
What is the debt ceiling?
The debt ceiling is a limit that Congress places on how much debt the federal government can issue to fund itself. It’s been around since 1917 and has been raised regularly since then. The federal government typically runs a deficit, meaning the difference between how much it makes from taxes and how much it spends. To cover that deficit—which this year is about $1.1 trillion—it issues bonds, which banks, companies and even whole countries (like China) buy up, thus allowing the U.S. to essentially stay in business. Add up each year's deficit, roll in what the government owes to the Social Security Trust Fund, and you get to just over $16 trillion, as of Dec. 24. That puts us right up against the current debt limit of $16.394 trillion.
Are we hitting it soon?
Yes. Yesterday, Treasury Secretary Timothy Geithner wrote a letter to congressional leaders saying that the federal government would hit the $16.394 trillion cap on Dec. 31. This was in line with estimates from a month ago that the federal government would exhaust its borrowing authority by late December.
Isn’t it time to panic?
Not quite yet. The letter also detailed the “extraordinary measures” the federal government could take to buy some time.
What are these “extraordinary measures”?
In the simplest terms, they involve not issuing debt. Treasury has the leeway to keep up to $200 billion worth of U.S. government debt from being issued to various entities, including state and local governments and certain retirement funds. If it did this, we’d buy ourselves about two extra months before hitting the ceiling.
The Bipartisan Policy Center, which has published a detailed analysis of government spending in January and February, estimates that the $200 billion will last through sometime in February.
What happens then?
This is what is known in debt-ceiling-wonk parlance as the “x-date,” when the government is strictly limited to its incoming tax revenue to make its payments, on everything from paying employees to agricultural subsidy payments to Social Security checks.
If you’re expecting a tax refund, you might have to wait a while. Interest on the government’s debt would likely be paid out first.
What happens to me?
Well, let’s see. If you’re expecting a tax refund, you might have to wait a while. Interest on the government’s debt would likely be paid out first, with Social Security benefits probably coming in second, and then maybe Medicare and Medicaid payments. After that, there are federal salaries and funding education programs. If the government could only spend what it takes in, other things would likely come first.
Has the government ever done something like this before?
While some states have experimented with limited versions of prioritizing payments, the federal government never has. Because this would be totally uncharted territory.
Why is paying interest on the debt so important?
This is why people are so concerned about hitting the debt ceiling as opposed to a situation where the federal government shuts down because the congressional appropriations for spending have expired (this happened in 1995 and 1996). Instead, if we hit the debt limit, the government would have to pick and choose between making payments that it is legally obligated to do. Since the government has a budget of about $3.5 trillion a year and issues just over $1 trillion worth of debt, the confidence among voters and investors all over the world is of paramount importance.
Not only is there some $11.5 trillion worth of Treasury debt held by investors all over the world, these bonds are used in all sorts of financial transactions and the interest rate the federal government pays on them is the baseline, or “risk-free” interest rate for trillions worth of financial transactions. Getting to a situation where there was uncertainty about whether the government could pay its debts, not to mention its other legal obligations, would be so unprecedented that the exact effects are hard to imagine.