The Debt Ceiling–an unbiased primer

12 07 2011

The U.S. Federal government will soon hit its debt ceiling.  This information has been in the news for some time, often with predictions of “doomsday” if the ceiling is not lifted.  Most of the news on the ceiling does not explain, in any sort of detail, explain what the debt ceiling is, why it is a perceived problem if we “hit” it, and why raising it is a solution to anything (other than to “hitting” the ceiling).  Here is a brief, unbiased explanation of what the debt ceiling is and its effect so that you can decide if it is a problem.

It is easy to explain “what” the debt ceiling is: the Federal government has a cap on the amount of money it can borrow.  If the Federal government reaches this limit, the Federal government can no longer borrow any more money.

What the debt ceiling is not: in the above, notice the emphasis on the word “borrow.”  The debt ceiling is NOT a limit on how much money the Federal government can bring in or spend.  For instance, in 2008, the Federal government brought in $2.66 TRILLION from taxes.  That money is unaffected by the debt ceiling, the Federal government will still collect a similar amount each year no matter what happens with the debt ceiling.  If the Federal government were a business, this would be its “Revenues.”

That same year, the Federal government spent $2.9 TRILLION.  If the Federal government were a business, this would be its “Expenses.”  Obviously, the Expenses were more than the Revenues, which leaves a “deficit” instead of a “surplus.”  The only way to spend more than you make from the ordinary course of business, is to borrow the difference.  That difference gets added to the negative balance that has accrued from past years, which is the total debt amount.

As you can see, if the Expenses are less than or equal to the Revenues, there is no deficit and no additional debt.  In other words, if Expenses are the same as Revenues, the Federal government does not move closer to the debt ceiling and the debt ceiling has absolutely no effect on anything.  Similarly, if Expenses are less than Revenues, the Federal government actually moves away from the debt ceiling, and again, the debt ceiling has absolutely no effect on anything (other than to leave more “room” for borrowing in the future).

So why might it be a problem to reach the debt ceiling? If the Federal government cannot borrow any more money, then the most it can spend is the amount it brings in.  Any spending beyond its revenues is impossible (more accurately, any spending beyond its revenues is unconstitutional).  In other words, it can “only” spend $2.66 TRILLION a year (if we use 2008 numbers), and will be forced to cut discretionary spending.  In 2008, mandatory spending was $1.788 TRILLION, the rest was spending.  So the Federal government will still be able to cover all of it’s “mandatory” spending, which includes: Social Security, Medicare, Medicaid, and Federal debt interest.

Notice that Federal debt interest is a “mandatory” expense.  This prevents a default.  But the Federal government will be forced to cut “discretionary” expenses.  It will do this by laying off some Federal government employees and cutting back on some benefit programs.  These programs can grow in the future as revenues grow, or the Federal government can leave them at a smaller size and have a surplus in its budget.

Will these cutbacks affect you? That is for you to decide.  Two things are clear though: (1) we are not facing a total shutdown/Armageddon and (2) some people will be affected.

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20 07 2011
The U.S. Debt Ceiling–a simple analogy « SolutionsLLP

[…] a past post, I gave an overview of the debt ceiling issues.  I recently explained this to a very confused […]

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