US Debt Ceiling Issue Explained [UPSC Notes]

United States Treasury Secretary Janet Yellen warned of the US defaulting on debt by June 1 if the House of Representatives and President Joe Biden’s White House fail to reach an agreement to raise or suspend the debt ceiling. In this context, understand what is meant by the US debt ceiling and what the current issue is all about. This topic is relevant for the IAS exam economy as well as international relations segments.

United States Debt Ceiling

The US Federal Government borrows money due to the budget deficit where expenditure is greater than revenue. Since 2001 the budget deficit has averaged $1 trillion annually.

• The Government borrows by issuing debt securities like bonds to investors and a large part of the money is kept by the US government for social security schemes, medicare, federal pensions, etc. 
• The taxation and spending are decided by the administration and Congress, and the borrowing is done by the US treasury department.
• With the passing of the second Liberty Bond Act in 1917, the President was allowed to withdraw funds without the approval of absent lawmakers while also imposing a debt ceiling which can be raised only with the approval of Congress.
• The present-day format of the debt ceiling was reached in 1939 which consolidated separate borrowing limits for bonds into one debt ceiling at $45 billion.
• The US government has faced the threat of breaching the debt limit multiple times and Congress has acted 78 times since 1960 to either permanently raise, temporarily extend, or revise the definition of the debt limit
• The US hit the present debt ceiling limit of $31.4 trillion in January 2023 and the treasury initiated the extraordinary measures mechanism to allow the government to meet expenditures.
• The government will default on debt if it runs out of cash, extraordinary measures are exhausted and the debt ceiling is not raised.

Cause of Debt Ceiling Standoff

• The stand-off is recurring because Congress does not have the entire amount of funding when it approves programmes and there is a limit on borrowing by the treasury to pay for already borrowed programmes.
• For example, if Congress approves $100 of spending then $70 comes in taxes and for the rest of the amount due to the debt ceiling the government can only borrow $15. 
• Another reason for recurring stand-off is due to polarization of politics which results in Congress imposing conditions on debt hikes.
• In 2011 the stand-off reached a peak when Republicans and Barack Obama administration could not reach an agreement which resulted in rating firm S&P downgrading ‘AAA’ credit ratings.
• This resulted in a government shutdown, shocks in the financial market and a huge stock sell-off.
• Economists are calling for removing the debt ceiling as it is not contributing to fiscal discipline anymore and poses a risk to global financial stability.

Magnitude of the US Government Debt:

• Total government debt has risen from $9.49 trillion in June 2008 to approximately $31.4 trillion at present.
• The debt-to-GDP ratio has increased from 63.85% in June 2008 to over 120%.
• This indicates that US debt has nearly doubled over the past 15 years.

Potential Impact of US Defaults

• The USA has never defaulted on its debt before. However, experts are warning of dire consequences such as a financial crisis in case of default. The US government will be unable to pay:
  • Military salary
  • Pension
  • Interest on bonds
  • Other consequences such as the downgrading of credit rating, stock sell-off, job loss, weakening of the dollar, rise in national debt and consequent rate hike, etc.
• Loss of confidence in the US economy will result in a weakening of the dollar due to investors selling treasury bonds.  

The Demand of Republicans:

• The current impasse is said to be more severe than in 2011. The bill passed by Republicans combines a $4.8 trillion in spending cuts with an increase in the current $31.4 trillion debt ceiling. 
• The Bill would cut a wide range of government spending back to last year’s (2022) levels, leading to a decrease of $4.8 trillion or about 9%.
• However, US President Biden wants a clean debt-ceiling hike and doesn’t want to negotiate any kind of cuts, resulting in the current deadlock.

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