US Debt Ceiling Issue Explained | UPSC Notes | Testbook.com

Understanding the United States Debt Ceiling

The US Federal Government often finds itself borrowing money due to the budget deficit, a situation where the government's expenditure surpasses its revenue. The budget deficit has averaged around $1 trillion annually since 2001.

• The Government borrows by issuing debt securities like bonds to investors. A significant portion of this borrowed money is utilized by the US government for social security schemes, medicare, federal pensions, and more.
• The decision on taxation and spending is made by the administration and Congress, whereas the borrowing is executed by the US Treasury Department.
• The second Liberty Bond Act, passed in 1917, allowed the President to withdraw funds without the approval of absent lawmakers. It also introduced a debt ceiling, which can only be raised with the consent of Congress .
• The modern format of the debt ceiling was established in 1939, consolidating separate borrowing limits for bonds into a single debt ceiling set at $45 billion.
• The US government has encountered the risk of breaching the debt limit several times. Since 1960, Congress has taken action 78 times to either permanently raise, temporarily extend, or revise the definition of the debt limit.
• In January 2023, the US hit its current debt ceiling limit of $31.4 trillion. The Treasury Department then initiated the extraordinary measures mechanism to allow the government to meet its expenditures.
• If the government runs out of cash, exhausts its extraordinary measures, and fails to raise the debt ceiling, it will default on its debt.

Causes of the Debt Ceiling Standoff

• The standoff recurs because when Congress approves programs, it often lacks sufficient funding. The treasury's borrowing capacity is also limited due to the debt ceiling.
• For instance, if Congress approves $100 in spending, $70 is covered by taxes. Due to the debt ceiling, the government can only borrow $15 for the remaining amount.
• The growing polarization of politics is another cause for the recurring standoff, with Congress often imposing conditions on debt hikes.
• The standoff peaked in 2011, when Republicans and the Obama administration couldn't reach an agreement. This led to rating firm S&P downgrading the US' ‘AAA’ credit ratings.
• This caused a government shutdown, financial market shocks, and a significant stock sell-off.
• Economists are now advocating for the removal of the debt ceiling, arguing that it is no longer contributing to fiscal discipline and is instead jeopardizing global financial stability.

The Magnitude of the US Government Debt:

• The total government debt has surged from $9.49 trillion in June 2008 to approximately $31.4 trillion currently.
• The debt-to-GDP ratio has escalated from 63.85% in June 2008 to over 120%.
• This signifies that the US debt has nearly doubled over the past 15 years.

Potential Impact of US Defaults

• While the USA has never defaulted on its debt before, experts are cautioning about severe repercussions such as a financial crisis in case of default. The US government would be unable to pay:
  • Military salary
  • Pension
  • Interest on bonds
  • Other repercussions could include a downgrade of credit rating, stock sell-off, job loss, weakening of the dollar, rise in national debt and subsequent rate hike, etc.
• A loss of confidence in the US economy could lead to a weakening of the dollar as investors sell off treasury bonds.

Republicans' Demand:

• The current deadlock is reportedly more severe than in 2011. The bill proposed by Republicans merges $4.8 trillion in spending cuts with an increase in the current $31.4 trillion debt ceiling.
• The Bill seeks to reduce a broad range of government spending to the levels of the previous year (2022), leading to a decrease of $4.8 trillion or about 9%.
• However, President Biden is pushing for a clean debt-ceiling hike and is refusing to negotiate any kind of cuts, leading to the current impasse.