by Taylor J. Kovar – CEO / Founder, Kovar Wealth Management
–Hey Taylor – Huge request: can you explain the debt ceiling without getting into the politics of it? I just want to know what it is and how it works without getting into a debate.
–Hey Stephen – A man after my own heart! It’s fun to learn things without having to fight about it. I’d love to help out—the debt limit is a strange, fascinating, problematic thing that more people should understand since it turns into a hot-button issue every few years.
In the most straightforward way, the debt ceiling is how much debt our government is allowed to have. Theoretically, we can have as much as we want (and at over $31 trillion, we have a whole lot of debt). The Constitution says Congress needs to authorize any borrowing, and so the debt limit was initially set up as a way to give the U.S. Treasury more flexibility when it needed to borrow money, particularly during wartime. As long as the dead didn’t exceed ____, the Treasury could borrow.
That means, originally, establishing a cap on our debt was meant to make government finance a smoother operation. Obviously, that’s not how it always plays out anymore.
Because of the amount of debt we carry, the limit needs to be raised all the time. Some years it’s a formality that no one hears about; other years, Congress makes it more of an issue and a negotiating tool.
Two key factors that some people miss when talking about the debt ceiling. First, the vote to raise the debt limit isn’t a vote to spend more money. The government passes massive spending budgets which force us to borrow more; the debt ceiling then has to get raised to cover the borrowing costs of the budget that was already passed. Anytime the debt limit comes up for debate, it’s in relation to spending that’s already been approved by Congress, sometimes years prior.
The second issue is that no one knows what will happen if the ceiling doesn’t get raised because it’s never happened before. The fear is that the U.S. would default on debts, not be able to pay bondholders, and the ripple effect would shake the global economy. The U.S. could also have our credit rating downgraded, which would make future borrowing more expensive.
Government spending is a big issue. It will always be hotly debated in Congress. The debt limit, while different than a spending limit, is representative of the small government versus big government spending argument. Since the Treasury can estimate a window when the debt limit will be reached, it sets a tidy deadline for this debate, even if raising the debt ceiling won’t actually change our spending habits.
Hopefully, this makes things a little clearer. It’s fun to learn the history behind modern-day political spats—it makes it a lot easier to make sense of the jargon you hear on the news. Thanks for the question, Stephen!
