The Debt Crisis: FAQs
In what has become a fairly regular occurrence in recent years, the federal government is heading towards a possible debt crisis later this spring.
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We are at this point because the government has nearly reached the “debt ceiling,” the legal limit on how much money it can borrow to pay is obligations, but Congress and the White House cannot agree on how to raise the ceiling. If the ceiling is reached and the government cannot borrow more money to pay its bills, it could default on its existing debt, sending shockwaves throughout the U.S. and global economy.
To understand the crisis and what it means for you, here are some FAQs on the debt crisis.
Why Does the Government Need to Borrow Money?
Why Won’t Congress Just Raise the Debt Ceiling?
When Will the Debt Ceiling be Reached?
How is a Debt Default Different from a Government Shutdown?
What Would Be the Impact if the Debt Ceiling is Reached?
Without A Debt Ceiling Increase, Can the Government Use Other Methods to Avoid Default?
Couldn’t the Government Just Prioritize Certain Payments?
What Would a Debt Default Mean for Government Employees and Contractors?
What is the Debt Ceiling?
The debt ceiling is the legal limit on how much money the U.S. government is allowed to borrow in order to meet its financial obligations (it’s somewhat akin to the credit limit on your credit card). It’s important to note that raising the debt ceiling, in of itself, does not give the federal government the authority to create new programs or spend more money; it simply enables the government to pay for debts already incurred, such as programs that previous Congresses and the Presidents created and funded.
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Why Does the Government Need to Borrow Money?
For decades, the federal government has spent more money (on social programs, defense spending, and entitlement programs like Medicare and Medicaid) than it takes in, mostly in the form of taxes.
Because the federal budget typically runs a deficit each year, the U.S. Treasury must borrow money, mainly by issuing bonds, to cover the difference. The total of all the accumulated annual deficits is the national debt, which currently is above $31 trillion.
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Why is There a Debt Ceiling?
The U.S. Constitution provides that only Congress has the authority to borrow money and pay the government’s debts. The debt ceiling was originally created during World War I, as a way to make it easier for the federal government to borrow money (before that, the Treasury had to get permission from Congress each time it wanted to borrow).
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Since the end of World War II, Congress and the President have raised the debt ceiling more than 100 times, under both Democratic and Republican administrations. The current debt limit, set in 2021, is $31.381 trillion.
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Why Won’t Congress Just Raise the Debt Ceiling?
The two parties are at loggerheads over raising the debt ceiling. Democrats, who control the White House and the Senate, support passing a “clean” debt ceiling bill, meaning a bill that either raises the debt ceiling or suspends it for a period of time, and does nothing else. Republicans, who control the House, say they will approve a debt ceiling increase only if paired with spending cuts and other policy changes. In late April, House Republicans passed a bill to raise the federal debt limit by $1.5 trillion or suspend it through March 31, 2024, in exchange for a range of Republican-backed spending cuts, an expansion of work requirements for some entitlement programs and energy and regulatory policies.
The GOP’s argument is that the U.S. should not increase its borrowing capabilities unless it also cuts future spending, to avoid future debt crises. Democrats respond that Republicans are in essence holding the debt ceiling hostage in order to advance policy goals that they otherwise would not be able to get passed.
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When Will the Debt Ceiling be Reached?
Technically, the debt ceiling was already reached on January 19, 2023. Since then the Treasury Department has been using what it terms “extraordinary measures,” generally fiscal accounting tools that enable it to move money around to keep paying the bills. However, Treasury is now saying that they will fully exhaust those measures in early June.
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How is a Debt Default Different from a Government Shutdown?
Government shutdowns happen when Congress fails to pass an annual appropriations (spending) bill for one or more federal agencies, or even a short-term funding measure. Because federal agencies are not allowed to spend money that Congress has not appropriated, they must cease operations (except for essential functions) until Congress approves a funding bill.
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In a debt default scenario, government agencies could remain open, but they would not be able to pay out any money – to employees, contractors, and any other beneficiaries.
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What Would Be the Impact if the Debt Ceiling is Reached?
If the government exhausts its extraordinary measures and runs out of money, it would be unable to borrow additional money and pay its bills.
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In practice, this would mean that all government payments, from Social Security checks to Medicare reimbursements to paychecks for civil servants and military personnel would not go out. Moreover, the government would not be able to make required interest and other payments to bondholders, from when the government previously borrowed money. This would mean a government default, which has never happened in the country’s history.
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Although nobody knows for certain the magnitude of the impacts, most economists believe that it would be devastating to the U.S. and global economy. Because global markets rely upon the stability and reliability of the U.S. government, a default would cause panic in world stock markets. Banks and international investors would be less likely to see U.S. securities as reliable investments, which would make it more expensive for the U.S. government to borrow money.
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It also would lead to the nation’s credit rating being downgraded, which would make it more expensive for the country to borrow. As interest rates on U.S. securities increase, other interest rates across the economy would also rise, making it costlier for consumers and businesses to borrow. Mortgage rates would go up, and businesses would be forced to borrow less to invest in new equipment and staff.
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A debt default also could push the economy into recession. Moody’s Analytics estimated in 2021 estimated that a default could lead to a 4-percent reduction in Gross Domestic Product, nearly 6 million lost jobs, and an unemployment rate of 9 percent. Moody’s also predicted a $15 trillion loss in household wealth as a result of a debt default.
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Ironically, a debt default would increase the federal government’s debt even more as higher interest rates meant future borrowing would be more expensive. The Government Accountability Office (GAO) has estimated that the 2011 debt ceiling standoff raised borrowing costs by a total of $1.3 billion in Fiscal Year 2011.
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Without A Debt Ceiling Increase, Can the Government Use Other Methods to Avoid Default?
It’s unclear. Some have argued that the 14th Amendment to the U.S. Constitution, which states that “the validity of the public debt of the United States, authorized by law … shall not be questioned,” overrides the debt limit, meaning that the government can continue borrowing money regardless of the limit. However, this legal theory has never been tested.
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In addition, some have suggested that the government could get around the debt limit by selling gold, or even by minting a trillion dollar coin. However, none of these schemes has ever been tried, and the economic and political ramifications of doing them are unknown.
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Couldn’t the Government Just Prioritize Certain Payments?
Some have argued that, if the debt ceiling is reached, the federal government could choose to pay certain obligations and not others. They note that, even if the government can’t borrow money, it will continue receiving revenue in the form of tax payments, and can use that income to pay some of its bills.
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However, there is no mechanism under current law that enables the Treasury to choose which bills to pay and which to avoid. Even if they had that authority, such choices would be extraordinarily difficult: do you pay bondholders, or send out Social Security checks to seniors? In addition, most economists warn that such a move would still damage the government’s creditworthiness and reputation as it would show that the U.S. is unable to pay all its obligations.
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What Would a Debt Default Mean for Government Employees and Contractors?
Unlike in a government shutdown due to a lack of an appropriations bill, if the government defaults, agencies could remain open and employees and contractors could still work. But the government would not be able to issue paychecks for employees or make payments to contractors, since it would essentially be out of cash. It is possible that agencies would furlough workers since they could not be paid, or ask them to continue working with the expectation they would be paid when the crisis passes.
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Federal contracts are generally prohibited from including any contingencies for delayed payments, and contractors are not allowed to charge the U.S. Government interest on borrowing to cover contracting work. However, the Prompt Payment Act provides that the federal government will pay interest on invoices that are not paid according to the terms of the contract. But if the government cannot borrow money, it would not be able to pay interest until the debt ceiling is raised.
Government contracting experts recommend that contractors make sure that any invoices already submitted are paid promptly, and to submit invoices for new work as soon as possible to ensure payment before a debt crisis begins.