The federal government was once again teetering on the brink of default this summer, leading to headlines buzzing about the debt ceiling.
But you might be wondering what the debt ceiling actually is and how it could affect you. If so, you’ve come to the right place.
What Is the Debt Ceiling?
The debt ceiling refers to the maximum amount of money the United States federal government can borrow to fulfill its existing legal obligations. Similar to how you can borrow only up to a certain limit with a credit card, the federal government can borrow only the amount allowed by the debt ceiling, also known as the debt limit.
“The debt ceiling is one of the yardsticks for measuring the state of the economy’s finances. When the country is closer to its debt ceiling, it either shows that the country has low revenue production, needs more funds to accommodate improvement or might be taking up more than it can handle,” says Mark Stewart, certified public accountant at Step by Step Business, which helps clients start, run and grow their own companies.
“This can affect Americans because to pay off these debts, the government may increase taxes or set up policies that reduce purchasing power and lower the living standard,” Stewart says.
[Related:READ: 15 Steps to Achieve Financial Freedom.]
Why Does the U.S. Have a Growing National Debt?
When federal spending outpaces revenue for a fiscal year, the government borrows to cover the deficit. The result is a growing national debt.
Over the last 100 years, the national debt has risen from $408 billion to more than $32 trillion. In 2022 alone, the federal government collected $4.90 trillion in revenue and spent $6.27 trillion — leaving a deficit of $1.38 trillion.
About three-quarters of the outstanding debt is held by the public, mostly in the form of U.S. Department of the Treasury-issued securities. The other quarter is held by government accounts, most of which go to trust funds for Medicare, Social Security, military retirement and civil service retirement.
[Related:Household Debt Surges at Fastest Pace Since 2007]
What Does It Mean to Raise the Debt Ceiling?
Raising the debt ceiling refers to Congress increasing the amount of money the federal government can borrow to meet its financial obligations, which enables a larger national debt.
In December 2021, for example, Congress increased the debt ceiling by $2.5 trillion to a limit of $31.4 trillion. But that was far from the only occasion. It has acted to increase, revise the definition of and extend the debt ceiling 78 times since 1960.
“Any change to the debt ceiling requires majority approval by both chambers of Congress. It’s a complex issue that requires careful consideration and negotiation,” says James Allen, CPA and founder of the personal finance firm Billpin.
What Does It Mean to Suspend the Debt Ceiling?
Along with increasing the debt ceiling, Congress can also suspend it for a set period, which removes the limit.
When the suspension comes to an end, Congress then increases the debt ceiling to accommodate the borrowing that has taken place. This approach was part of the Fiscal Responsibility Act of 2023, which suspended the debt ceiling until January 2025.
“An increase in the debt ceiling means that the government will continue to fulfill its promises, but it also means that the U.S. will continue to borrow more money, which will weaken the value of the U.S. dollar,” says Blake Harris, founding principle of Blake Harris Law in Miami.
Where Does the U.S. Borrow Money From?
When the national debt is below the debt ceiling, the government borrows money from marketable securities like Treasury bonds, notes and bills.
“The U.S. borrows money by issuing Treasury securities, which are bought by both domestic and international investors,” says Allen.
Once the government reaches the debt ceiling it can take “extraordinary measures” for a limited time, such as borrowing from fund programs or services. When those measures are exhausted, however, the U.S. will default on its debt if Congress doesn’t increase or suspend the debt ceiling.
What Happens if the U.S. Defaults on Its Debt?
If the U.S. federal government defaults on its debt, it will set off a domino effect causing irreparable harm to the economy, the livelihoods of Americans and global financial stability.
“U.S. Treasury securities are seen as a benchmark for reliability, contributing to the value and status of the U.S. dollar as the world’s reserve currency. A default or even uncertainty surrounding a default could lead investors to sell U.S. Treasury bonds, potentially weakening the dollar,” Allen says.
“This could have a ripple effect on the market for treasuries, causing the value of these reserves to drop — and could potentially push some emerging economies into debt or political crises,” he adds.
[Read: What Happens if You Don’t Pay Your Debts?]
Mark Zandi, chief economist of Moody’s Analytics, predicts that even a short debt limit breach could lead to almost 2 million lost jobs, a 5% unemployment rate, a decline in real gross domestic product and lingering high-interest costs as Treasury securities lose their risk-free reputation with global investors.
Further, the White House shared a similar opinion saying a default would cause a financial crisis and put the U.S. in a deep economic hole.
While debt ceiling increases and suspensions are serving as temporary fixes, the threat of an economic downfall will persist until the government finds a solution for the underlying problem of overspending.
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The Debt Ceiling: What It Is, Why It’s Important and How It Affects You originally appeared on usnews.com
