What is the Debt Ceiling?

What is the debt ceiling?

The debt ceiling, or debt limit, is the total amount of money the US government is authorised to borrow

It was first introduced in 1917 when Congress set a statutory limit on the amount of debt the government could have. 

The US government debt is an accumulation of all the borrowing the US has done up to a given point in time. This is not to be confused with its deficit, which measures the amount of borrowing in a set period, typically a year.  

The US government is in a constant state of debt – meaning it spends more than it collects in revenue.  

The first-ever debt ceiling was set at $11.5 billion. Today, it stands at $31.4 trillion. In June 2023, the Senate passed a bill to suspend the nation’s debt limit until January 1, 2025.  

The debt ceiling has been raised or suspended numerous times to avoid the US government defaulting on its debt. 

What does suspending the debt ceiling mean? 

Following warnings from the Treasury that the US would run out of money on June 5 and weeks of subsequent political negotiations, House of Representatives Speaker Kevin McCarthy and President Joe Biden reached a deal to suspend the debt ceiling. 

This deal was subsequently passed by Congress and narrowly by the Senate, avoiding the first ever federal default in US history.  

Rather than raising the debt ceiling – which is increasing the amount of money the country can be in debt – suspending it allows the US Government to define a period of time before the debt limit needs to be addressed again.  

This is not the first time a deal has had to be struck to prevent the US from defaulting on its obligations. 

According to the U.S. Department of the Treasury, since 1960, Congress has acted 78 separate times to permanently raise, temporarily extend or revise the definition of the debt limit. As they put it, congressional leaders from both parties have recognized this is necessary. 

Why is US debt so high? 

Since 2001, the US government has averaged nearly a $1 trillion deficit. To finance payments Congress has already agreed to, it has to borrow – getting further into debt.   

This amounts to quite a hefty sum.   

Like rolling a snowball down a snow-covered hillside, the debt has continued to grow and get bigger as time passes.  

President Reagan’s 80s tax cuts, the Cold War, the 2001 recession, the wars in Iraq and Afghanistan, the 2008 recession, President Trump’s tax cuts, and the Covid-19 pandemic have all bolstered the national debt.   

So, what happens if the US government hits the debt ceiling? 

Chaos, catastrophe, and calamity are all words being used to answer this question.   

The U.S. Treasury doesn’t pull any punches either; it says failing to increase the debt limit will have “catastrophic economic consequences.”  

What happens if the US government hits the debt ceiling? 

The debt ceiling limits what the US government can borrow to meet its existing legal obligations, including Social Security and Medicare benefits, military salaries, interest on the national debt, tax refunds, and other payments. 

A huge chunk of the population stands to be affected if that limit is hit.  

According to Moody’s, breaching the debt ceiling would spike interest rates, plunge equity prices, and shut down short-term funding markets essential for the flow of credit finance necessary to fund  day-to-day economic activities.  

The international financial research company said even a short debt limit breach could cause a decline in real gross domestic product (GDP) and cost nearly two million jobs. 

A default would impact every corner of the US. Recession, unemployment, job losses, and a spike in the cost of living are just some consequences people can expect. 

 For those looking to borrow, including students, a debt ceiling default could make this even more difficult.   

For different segments of the population, this is what it could look like:  

Approaching retirement 

President Biden himself warned that defaulting on the national debt would “devastate retirement accounts.” So how bad could it be? 

A typical worker near retirement with 401(k) savings could lose thousands if the US defaults on its debt. 

Retirees who depend on Social Security to help pay bills or Medicare to cover healthcare would also be impacted. According to The Wall Street Journal, these checks could be delayed or temporarily reduced.  

Debt ceiling defaults and even standoffs hurt the stock market. According to a CBS News report, during the 2011 debt debate, the stock market fell by 14% over four weeks.  

Moody’s suggests a default could result in the stock market plunging by one-third, erasing $15 trillion in household wealth.  

As 401(k) and other retirement plans are so closely linked to the stock market, this is a huge cause for concern, especially for those who plan to retire soon.  

Buying or selling your home 

According to Zillow, hitting the debt ceiling could greatly impact the already struggling housing market.  

They predict house prices could rise by 22%, with almost 12% of the six million homes expected to be sold in the 18 months after July, never making it passed the ‘For Sale’ sign. This is around 700,000 homes.  

With lending and credit availability greatly reduced throughout the financial system, the cost of home borrowing would rise dramatically. They suggest the rate for a 30-year fixed mortgage could rise above 8%.  

The value of your home will also likely fall. In the event of a default, prospective home sellers could see the value of their home drop by 5% by the end of 2024.  

Taxpayers 

The US government spends more than it gets from taxes and other revenue streams. This means taxpayers could bear the brunt if it needs to increase what it takes in because it hit the debt ceiling.  

It could also spell trouble for those waiting on tax refunds – if government debt reaches its limit, the government would have to default on interest payments and other obligations, including tax refunds.  

In 2011, the debt ceiling showdown cost taxpayers an estimated $1.3 billion during that fiscal year and $18.9 billion over 10 years. 

According to The White House, there has already been significant market stress due to debt ceiling tensions. 

Yields on Treasury bills with maturity dates around the X-date – the date the Government can no longer pay its bills – have increased considerably. This directly increases the government's borrowing cost and thus, the cost to taxpayers.  

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