What Is The Debt Ceiling — And What Happens If Congress Can't Raise It In Time?

An inability to agree on the conditions surrounding a raise of the national debt ceiling has put the U.S. on the verge of default.

While President Joe Biden and House Speaker Kevin McCarthy are set to meet on Tuesday to negotiate a deal for the new raise, Treasury Secretary Janet Yellen is warning of the economic catastrophe that would arise should the factions fail to agree before the government runs out of cash.

U.S. Debt, Explained

Like any household or business, the U.S. government has obligations for which it needs money. 

In fiscal year 2022, the federal budget's main spending categories were:

• Social Security (19%)
• Health programs like Medicaid (15%)
• Income Security (14%)
• National Defense (12%)
• Medicare (12%)
• Education, Training, Employment, and Social Services (11%)

All of these cost the government $6.27 trillion. $4.9 trillion came from revenue sources, while $1.38 trillion had to be borrowed.

The federal government's main source of revenue are taxes, such as income taxes, payroll taxes, corporate income taxes and excise taxes. Yet money coming in from these sources is hardly ever enough to cover all the spending the government does.

Almost every year since the nation was founded, income was less than spending. This is called the federal deficit, and to make up for it, the government has to borrow money. It does so by issuing bonds that investors can purchase and later exchange for the same money plus interest.

Read also: How To Buy Bonds

The COVID-19 pandemic forced the government to raise the rate of borrowing in order to keep the economy alive. The 2020's deficit was the highest since World War II, at $3.13 trillion.

For fiscal year 2023, the government has a deficit of $1.10 trillion. The Treasury Department sells bonds in order to finance its deficit. These are held by investors who the government needs to pay once those bonds expire. Many of those investors are normal American residents, but private funds, government funds and foreign governments also make up a large portion of the government’s creditors.

Japan and China, for instance, each hold $1 trillion in U.S. debt.

Today, the national debt — which piles up the deficits from every previous year— amounts to $31.46 trillion, having tripled in the last 20 years.

What Is The Debt Ceiling And What Happens Now That We've Hit It?

Unlike many countries, the U.S. has a limit on how big the national debt can get. Congress needs to approve government borrowing and has the power to either raise or suspend the debt limit, also known as the debt ceiling.

The logic behind this dynamic is to keep government spending within sensible limits. Raising the debt ceiling is a normal operation. Since 1960, Congress has raised the debt limit 78 times, the most recent being a $2.5 trillion raise in 2021.

The treasury hit the current debt limit of $31.4 trillion in January of this year, after which it began executing "extraordinary measures" in order to avoid a default, which included suspending investment in government funds, among other measures.

A government default comes when the government essentially runs out of money to pay its bills, and is unable to borrow anymore because of the debt ceiling.

Yellen said that these measures could only sustain government spending until June 1 of this year, after which the Treasury would enter default, meaning it will have no more money to pay federal salaries and make payments on government programs such as Medicaid and Social Security.

The consequences of hitting the debt ceiling can shake the U.S. economy from the ground, as the event would replicate across the financial market. In 2011, when the U.S. became close to hitting its ceiling, stock prices across the market dropped greatly and took over six months to recover.

Furthermore, defaulting would mean that the government would not be able to make payments to its creditors, as clearing government debt is another of the Treasury's obligations. 

This would hurt the country's credit rating, making it harder for it to borrow money in the future, further adversely affecting the economy across the board.

If the government is unable to pay bondholders, the increased risk of lending to the U.S. government would be passed down to the population, raising the cost of borrowing money for the average resident and business.

One Goldman Sachs chief economist said recently that failing to pay government salaries, bondholders or social security recipients would reduce the U.S. economy by 10%, as a large amount of spending power would be halted overnight.

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