What’s the debt ceiling?

The legal limit on borrowing by the federal government. Before 1917, Congress had to approve borrowing each time it came up. In order to allow for more flexibility as the nation entered World War I, lawmakers agreed to give the federal government blanket approval for most types of borrowing — as long as the total was less than an established limit.

Why is this an issue now?

The nation’s debt is inching closer to the legal limit of $14.3 trillion. According to

Treasury Secretary Timothy F. Geithner, the ceiling could be breached as soon as May 16, though the government could take unconventional measures such as halting contributions to pension funds to delay that point until July 8.

What happens if the debt ceiling is breached?

If Congress does not increase the limit, borrowed funds would not be available to pay bills and the United States may be forced to default on its debt obligations. There’s no precedent for this situation. Treasury has never been unable to make payments as a result of reaching the debt limit. With a fragile global recovery counting on U.S. economic stability, the debt limit issue could roil international financial markets. Democrats and Republicans agree that if the debt limit is not raised we would be inviting economic catastrophe.

So if both parties agree, why not just raise the limit? What is everyone arguing about?

In the past, raising the debt ceiling has mostly been a perfunctory matter. The ceiling has been raised almost 100 times since it was established and has gone from less than $1 trillion in the 1980s to $6 trillion in the 1990s. The most recent time the ceiling was boosted was in February 2010. Legislation to raise the debt limit usually prompts partisan posturing about fiscal responsibility, but little real drama. This time is different.

With the national debt at its highest point in 50 years compared with the size of the U.S. economy, the debate about the ceiling has become entwined in the larger issue about slashing the budget. The budget debate is shaping up around trying to balance two perhaps equally unpopular remedies: sharp cuts to popular government-funded programs and major tax increases. Republican lawmakers say that if they raise the limit they need a commitment from the White House for more spending cuts. The Obama administration has resisted the idea of including spending caps or other budget-process reforms in legislation to raise the debit ceiling, arguing that ensuring the government’s solvency is too important to be held hostage to other issues.

What happens if we don’t raise the debt ceiling but continue to pay interest on our bonds?This is an option known as “prioritization.” The Bipartisan Policy Center released a report attempting to think through how this would work in practice, as it has never been attempted before. The raw numbers are chilling: In August, the federal government would have to cut expenditures by about $134 billion, or 10 percent of the month’s GDP. If it chose, for instance, to fund Medicare, Medicaid, Social Security, supplies for the troops and interest on our bonds, it would have to stop funding every other part of the federal government. The drop in demand, when coupled with the turmoil in the markets and the general financial uncertainty, would undoubtedly throw the economy back into a recession. Also keep in mind that we have to roll over $500 billion in debt that month, and if there was uncertainty about how we were going to pay our bills, it is not clear we could find buyers for our debt at anything less than an exorbitant rate. In this way, “prioritization” could actually increase the deficit.

What happens if we stop paying the interest on our debt? This is too scary to consider for any serious length of time. Treasury securities sit at the base of the global financial system. They are considered so safe that the interest rate on Treasuries is called the “riskless rate of return,” as the market assumes there is no chance of default under any circumstances. Almost all other types of debt — mortgages, credit card, auto loans, business loans, hospital bonds, etc. — are yoked to Treasuries. Almost all major financial players hold substantial portfolios of Treasuries or Treasury-related debt in order to buffer themselves against financial shocks. Consider that the 2007 financial crisis was caused by the market realizing it had to reassess the risk of bonds based on subprime mortgages. If the market has to reassess the risk of Treasuries, the resulting financial crisis will be beyond anything we’ve ever seen in this country.

How much money are we talking about?

Under the spending plan President Obama submitted to Congress in February, lawmakers would have to raise the limit by nearly $2.2 trillion just to see the nation through next year. Under the more austere blueprint that House Republicans approved last week, the government would require about $1.9 trillion in fresh debt by October 2012 — a month before the next presidential election.

Why does the United States have so much debt anyway?

There are numerous reasons. Here are some major ones: Under President George W. Bush, the national debt soared to $4.36 trillion because of the cost of wars in Iraq and Afghanistan and new tax cuts, and again under Obama, an additional $3.9 trillion, because of the economic stimulus and decreased tax revenue during the recession.

Do we need a debt ceiling? Strictly speaking, no. The debt ceiling is unique to America. In other countries, when the legislature passes a law, the Treasury is given automatic authority to carry it out. A number of former Treasury Secretaries have said it should be abolished, including Larry Summers, who said, “I think that given that Congress has to approve all spending and all tax changes, there is not much logic to the debt ceiling.”

Does the debt ceiling reduce deficits? In general, no. The nonpartisan Congressional Budget Office examined this issue and concluded (pdf) that “setting a limit on the debt is an ineffective means of controlling deficits because the decisions that necessitate borrowing are made through other legislative actions. By the time an increase in the debt ceiling comes up for approval, it is too late to avoid paying the government’s pending bills without incurring serious negative consequences.”

Is the debt ceiling unconstitutional? A number of commentators have suggested that the 14th Amendment, which states that “the validity of the public debt of the United States ... shall not be questioned,” renders the debt ceiling unconstitutional. Others have disagreed, including Lawrence Tribe, a professor of constitutional law at Harvard, who notes that the Constitution gives Congress the sole power “to borrow money on the credit of the United States.” Ultimately, this point is probably moot, at least for the time being, as the Treasury Department has stated that it agrees with Professor Tribe’s interpretation.