by Timothy Kunken
Introduction
In recent years, one of the most contentious political debates has been brewing over the state of the United States’ national debt. The debt currently rests at around $31.46 trillion dollars, which inched above the legal limit as of January 19, 2023. This legal limit is known as the “debt ceiling,” and the debate it has spawned in both Congress and the White House has become a high stakes political battle that still remains unresolved.
What is the Debt Ceiling?
To understand the debt ceiling, you need to understand how the federal government pays for itself. As described under the Constitution, Congress has the power of the purse. They determine how much taxes are collected, how much is spent, and how much debt needs to be raised. Once a budget is made, the rest of the work is done by the Department of the Treasury under the President. They’re the ones who handle the flow of money from tax revenue into government services.
In theory, the amount of taxes raised should be enough to pay for the government programs set by Congress’s budget. However, there has always been a budget deficit, so debt has to be raised in order to make up for it. (It’s always more popular to spend big on projects than it is to raise taxes to pay for them.)
Even though Congress can raise debt themselves, they have delegated that role to the Treasury in the Secondary Liberty Bond Act of 1917. This allows the Treasury to raise as much debt as they need in order to pay for government operations without Congressional approval, so long as it rests under a certain limit.
This debt comes in the form of treasury bonds (T-bonds), which are bought by investors across the country and the world. In fact, the federal government owns debt in the federal government. For example, the money kept for social security and medicare are in the form of treasuries. Additionally, the largest single holder of these bonds is the federal reserve.
A typical treasury bond can work like this: Imagine you pay $1000 to the government for a 20 year bond at a fixed interest rate of 2%. Every six months, you get sent a check of $10.00. After 20 years of checks, the government gives your $1000 back. Boom: you’ve just got $1,400.00, meaning you earned $400.00 in extra profit. Despite having a lower interest rate than most bonds, T-bonds are very popular among investors particularly because they are very safe. They’re backed by the full faith and credit of the United States after all. Until 2011, (for reasons we’ll discuss later), treasuries have been consistently rated AAA+ ratings across countless credit rating institutions. When credit ratings are high, investors are willing to accept low interest rates. The lower the interest rate, the easier it is to take on debt. (TL;DR: it’s easier to borrow money if investors think you can reliably pay them as they balance risk vs. reward. T-bonds are considered low risk, low reward).
The debt ceiling, or the debt limit, is the legal limit set by Congress and the President over how much debt the Treasury Department can raise. This is important because budget bills are legally requiring the government to spend the exact amount of money set by law, meaning debt must be raised in order to fill in the gaps left by a lack of tax revenue. This creates a uniquely American contradiction: Congress sets a budget that needs to be paid off with debt. Then, Congress sets a law that stops the Treasury from taking on debt to pay for said budget, which was already imbalanced to begin with.
This playground game of “stop hitting yourself” can only go wrong. Once the debt reaches the debt ceiling, the Treasury must do everything it can in order to continue paying for government services without crossing the line. These actions, dubbed “extraordinary measures,” can include using the remaining stocks of cash it has left on hand, stopping the issuing of new treasury bonds, and many more. These are only short term solutions to the ticking time bomb that comes next: a debt default.
When the Treasury has no remaining options left to pay for government services, it has to default on its debt. This means that the government can no longer pay its investors in full or on time before the legal obligation to do so. This may seem unimportant, but it’s a big deal. It represents the shattering of the United States’ full faith and credit, the backbone of not just American finance but also global finance. We have never faced a default in our entire history, so we can’t say for certain how it will play out. Here’s what we can guess:
Credit ratings for U.S. bonds of all forms plummet into the floor. (For context, the reason the S&P U.S. credit rating dropped in 2011 was because of “political risks,” which came out of that year’s debt ceiling fight which narrowly avoided the risk of default.) This means interest rates across the board shoot up. Home loans, car loans, business loans — everything — will have their interest rates skyrocket, making borrowing of all kinds harder for everybody, not just the government. The stock market nosedives as investments witness a drought. The government will also have to delay payments for social security and health insurance, if not cut them entirely. Overall, the government will struggle to pay for its everyday functions such as maintaining its military and public services. If it lasts long enough, it will allow the country to descend into a recession, one that may spread to the rest of the global economy. The U.S. dollar will lose its credibility, which is drastic considering how widespread it is in global commerce. If there was one thing that can destroy both the American and global economy the fastest, it’s a default.
Even the threat of default causes economic turmoil. When the 2011 negotiations over raising the debt ceiling went longer than expected, the economy was still rattled. All it took was the whiff of uncertainty for Standard & Poors, one of the most accredited rating agencies, to downgrade the U.S. credit rating. That single firm’s decision alone sent shockwaves, causing a temporary dip in the stock market, with banks and financial stocks taking the biggest hit. This means that even if the U.S. dodges a default, the wait before a deal gets made still erodes consumer and investor confidence as each day goes by. As negotiations are stalling right now, the stakes couldn’t be higher.
(Pt. 2) The Politics of the Debt Ceiling
Why is the Debt Ceiling So Hard to Raise?
As with most problems in the American government, the issue isn’t that people don’t implement the right policies or have the right ideas. In fact, nearly all lawmakers can confidently say that reducing the deficit or avoiding a default is a fundamentally good thing…in theory. In practice, the debt ceiling isn’t an economics issue; it’s a politics issue.
The last time the debt ceiling was raised was in 2021, and the ensuing negotiations went somewhat smoothly. However, this current situation has one crucial difference. Since the midterm elections, the Biden administration is facing resistance in the midst of a divided government. While Congress was previously controlled by the Democratic party in both chambers early on in the presidency, now the House of Representatives has a Republican majority with Kevin McCarthy as the Speaker of the House. This means that even more concessions need to be made than before to satisfy the demands of various conflicting groups between Congress and the presidency.
The issues don’t only exist between the inter-party conflict. Conflicting voices and interests also exist within each party. This is the most apparent in the Republican party, which is notorious for recent infighting, especially during the House Speakership vote. Back in January, Kevin McCarthy had to appease various voices within his party in order to shore up the necessary votes to give him the leadership position. The most conservative wing of the party, known as the “Freedom Caucus,” gave staunch opposition in particular. Because they were a large enough bloc within the party to halt his chances of a successful vote, McCarthy had to make various concessions such as giving them top roles in various committees. Needless to say, his chances of retaining his role as Speaker after the next election depends on whether or not he can negotiate a peace with the Democrats in the White House and Senate that also appeases the Freedom Caucus.
In contrast, the Democratic party is more unified within the government. They hold a narrow, albeit comfortable 51-seat majority in the Senate. They’re also closely aligned with Joe Biden, not only because he’s a president of the same party, but also because he has strong ties to the Senate after his decades-long career as a former Senator. Biden also has recent experience in negotiating debt ceiling hikes. Even before the 2021 negotiations he participated in as President, he was also the chief negotiator of the notorious 2011 standoff along with other debt ceiling negotiations as Vice President under the Obama administration.
Here is the recurring scenario for when the debt ceiling gets breached: With a home-field advantage in the White House, the President naturally wants the debt ceiling to be raised as quickly as possible with little strings attached. No incumbent administration wants to endure a lengthy and arduous debate with Congress that leads to political bruising, especially with an election on the horizon. In contrast, any party in Congress opposing the current administration has a vested interest in delaying their chances at reaching a compromise as much as they can. This is because, with a default hanging above everybody’s heads, the President is more likely to tolerate concessions to the opposition than they would otherwise in times of peace. By the time tensions reach a boiling point as time starts running out, the opposition can offer a last-minute deal — a tough pill the President will eagerly swallow in order to avoid mutually assured destruction.
This delicate game of chicken is successful for the opposition only if they have enough leverage to back up their demands. If not, then the President and his supporters in the rest of Congress can simply call their bluff, not showing up to the negotiating table and waiting for the opposition to cave in and make their own limited compromise with the little power they have left. In this case, Republicans have more power in the current stalemate than they had in the 2021 negotiations; with a majority of House seats behind Kevin McCarthy as Speaker, his seat at the negotiating table carries more weight with it. Nevertheless, the strategy of any opposition can only work best as long as they stand behind a united policy. McCarthy and his fragile coalition will undoubtedly struggle to bargain effectively under their lack of cohesion.
As of today, negotiations have stalled with no deal yet in sight. This is because both factions hold different standards for how the negotiating process begins between them. For example, the White House is insisting that the negotiations begin after both submit their own budget proposals, while nevertheless keeping the prospect of a “clean” no-strings-attached debt ceiling bill close in their minds. In contrast, the House pushes back by refusing to draft their own budget proposal, opting instead to enter the negotiating room with a broad list of demands for reforms and spending cuts.
In March 9, the White House sent its own budget proposal to the House, which includes various reforms such as increased taxes on corporations and the wealthy, funding for universal pre-school, and an increase in defense spending (which is important considering how much military aid and weapons the United States has been giving to Ukraine over the past few months). Naturally, this bill was never intended to be voted on successfully, instead serving as a message to set the stage for negotiations. Since then, the House of Representatives hasn’t passed its own budget proposal. With this shortcoming in mind, the White House has used this as a talking point to criticize House leadership for not having its own plan in mind before negotiating.
The lack of a budget proposal is a symptom of how tenuous Kevin McCarthy’s hold on power is as House Speaker. With a very slim majority, the absence of a budget was also seen in the last Congress under a Democratic House. McCarthy’s position is particularly delicate, because any wrong step on his part can unravel his speakership. That is because, as a part of the deal that got him elected as Speaker, any single member of Congress can start a vote to replace him under a “motion to vacate.” If McCarthy ever tried to cram through a budget proposal that attempted to please both moderate and hardline members of his party, any disgruntled representative, let alone an entire group like the Freedom Caucus, can thrust him out of power.
Therefore, his best move was to present a list of demands painted under broad strokes. In a letter to President Biden, Kevin McCarthy included various goals such as reducing “excessive non-defense” spending to “pre-inflationary levels”, reclaiming unspent COVID-19 stimulus funds, strengthening work requirements for dependents who rely on federal assistance, reforms lowering energy costs, and measures that strengthened the U.S.-Mexico border. He continued outlining similar demands in his address to the New York Stock Exchange on April 17, adding that a “no-strings-attached debt limit cannot pass.”
These policy goals are just focused enough to attract the backing of his coalition in the House, while nevertheless steering clear of specifics. If McCarthy and his colleagues drafted a formal budget proposal, crunching the numbers and ironing out the finer details guarantees that some members of his party would be left dissatisfied. With a vote over a debt ceiling bill for the House “in the coming weeks,” the true test for Kevin McCarthy’s rule is on the horizon.
Thus is the current situation: the White House and Senate seek a swift and stainless end to the standoff. But, at the same time, they also sit comfortably as they wait for the ball to be served from the House’s court. In contrast, the House is just powerful enough to deny them a proper victory. But they’re also too divided to serve the ball back without tripping over the gaps in their coalition. It’s a web of contradictions.
With the X-date (the estimated day the Treasury defaults) in June, the deadline for a deal is rapidly approaching. Recent history suggests that we may barely graze past a default, but that possibility isn’t an absolute certainty. As partisanship in the government continues to escalate over the years, America’s economic web becomes more at risk of unraveling. Therefore, there’s only one thing we know for certain: this is a crisis of parties, not pennies.