User’s Guide to the Debt Ceiling: 5 Common Myths About the Deficit
With the clock ticking down to the estimated Oct. 17 debt ceiling deadline, it looks as if lawmakers are making strides to avoid hitting the $16.7 trillion borrowing limit.
House Republicans unveiled a six-week borrowing limit increase that doesn’t include a continuing resolution, and President Barack Obama has indicated he would sign it.
On Tuesday, Obama said he “would talk about anything” with Republicans in terms of negotiations, and warned of major economic repercussions if the limit was raised.
"Every American could see their 401(k)s and home values fall" and the country would see a "very significant risk" of a deep recession.
Officials in China and Japan chimed in earlier this week saying if the U.S. was unable to pay its bills it would hurt the global economy, particularly China as it hold close to $1.3 trillion in U.S. Treasury bonds.
As the negotiations continue on Capitol Hill with the White House, here’s a look at what Congress is debating and some clarification on some common misconceptions:
What is the Debt Limit? The debt limit is the total amount of debt the federal government can hold.
In 2011, the U.S. government spent $3.6 trillion. Here's how:
Mandatory Spending (13.5% of GDP, $2 trillion)
- Social Security (4.8% of GDP, $725 billion)
- Medicaid (1.8% of GDP, $275 billion)
- Medicare (3.2% of GDP, $480 billion)
- Other (3.6%, $545 billion)
Discretionary Spending (9.0% of GDP, $1.3 trillion)
- Defense (4.7% of GDP, $700 billion)
- Nondefense (4.3% of GDP, $646 billion)
Net Interest (1.5% of GDP, $227 billion)
*Source Congressional Budget Office
A cap on the federal debt has been in place since 1939 and prior to World War II, the limit was $45 billion. Now, the debt limit is set at $16.7 trillion. The Treasury Department can borrowing money from two sources: debt held by the public, mostly Treasury bonds owned by U.S. and foreign investors, and intra-government debt.
When Congress passes laws that require spending, Treasury needs to find the funds to cover the expenditures, and is forced to borrow money when tax revenue doesn’t cover federal spending.
“Once a law is passed, it has to be funded and [Congress's] spending actions have left us in a deficit and we cope with that deficit by borrowing money—right now we are going to the bond market because the rates are so cheap,” says Philip Wallach, fellow in governance studies at Brookings Institute.
In a worst-case scenario, if the debt limit isn’t increased, the U.S. could default on its current debt. Because our deficit spending is funded by Treasury bond sales, Uncle Sam needs to make payments to bondholders. If payments are missed, interest rates could jump.
Myth: We know exactly when the government will run out of money.
We know that we are running out of time and money to meet our debt obligations, but it’s hard to know exactly when the government will run out of money. Treasury Secretary Jack Lew told Congress the department expects to reach the debt limit no later than Oct. 17.
"If we have insufficient cash on hand, it would be impossible for the United States of America to meet all of its obligations for the first time in our history," he wrote in a letter to Congress on Oct.1.
But predicting the date isn’t an exact science, says Charlie Smith, chief investment officer at Fort Pitt Capital Group, a Pittsburgh-based wealth management firm. “Because of the inflow of tax receipts, Treasury can’t have an exact handle on its daily balance sheet.” While there could be some wiggle room for exactly when a breach would occur, Smith says there are two “drop dead dates.” On Oct. 23, a $12 billion tab for Social Security benefits is due, and on Oct. 30, a $6 billion interest payment comes up.
Myth: Treasury can easily prioritize payments.
Legal experts disagree on whether Treasury is legally allowed to prioritize which debt obligations it meets and Lew has said he won’t take this tactic, but Wallach points out that even if the department has the authority to make such decisions, technology problems get in the way.
“If we get to the point where we have to pick and choose, it has yet to be determine whether we can do so operationally. In other words, if we say, ‘we are going to pay this type of bill’ we don’t know if we go into accounting software to make sure those other bills are not paid,” says Brad McMillan, chief investment officer at Commonwealth Financial.
He adds that picking and choosing payments comes with a heavy political burden. “Do we really want just a few individuals making the decision on whether we pay interest on debt over Social Security benefits or military salaries?”
Myth: Increasing the debt limit means more spending.
Raising the debt limit does not mean spending will automatically increase along with the federal debt. Raising the ceiling allows Treasury to fund previously-passed spending obligations.
All spending decisions are made through the appropriations process. “Congress is the entity that determines spending, for Congress to say we can’t raise the debt limit because it will make us spend more is like a teenager saying if you give me a credit card, I will never blow it. We all know that isn’t the case, and why you give them a credit card with $500 limit,” says McMillan.
Myth: Our deficits are shrinking so therefore so is our national debt.
The federal deficit has decreased to its lowest level since 2008 and the Congressional Budget Office expects this trend to continue as the economy continue to improve and higher taxes on the wealthy starting flowing in. However, just because the deficit is decreasing doesn’t mean our national debt is also dropping.
“Every year we have a deficit the debt will continue to rise,” explains Smith. It’s not until the country starts running a surplus that we start reducing the country's debt.
Myth: No one thinks this will actually happen.
Lawmakers made progress on Thursday with the Republicans six-week borrowing limit increase proposal, Americans are worried about the game of chicken being played on Capitol Hill.
The latest Rasmussen poll says 62% believe the U.S. is likely to default on its debt.
Raising the debt ceiling tends to be a routine procedure on the Hill, but every once in a while, certain demands get attached to the bill that can cause a delay. And experts agree that this showdown has created a bigger fanfare. “We’ve always bargained about what is attached to debt ceiling, but the magnitude of the demands are historically unprecedented,” says Wallach.