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By Kimberly Amadeo, About.com Guide

U.S. Debt Ceiling

What It Is, and What Happens If It's Not Raised

Definition: The debt ceiling is a limit impose d by Congress on how

much debt the U.S. can carry at any given time. It's like a limit

impose d by your credit card company. The only difference is that

the government can keep s pending above the limit. However, it just

can't pay the bills its incurred by issuing new debt. It's like a credit

card that allows you to spend above your limit, but just won't pay

the bills that come in above the limit.

Congress created the debt ceiling in the Second Liberty Bond Act of 

1917. It allowed the Treasury Department to issue Liberty Bonds so

the U.S. could enter World War I. This Act also gave Congress the

ability to control government spending for the first time.

However, this is no longer necessary. In 1974, Congress created the budget process that allows it to control spending, That's why the debt ceiling is

usually raised. When the budget process wo rks smoothly, both houses of Congress and the P resident have already agreed on how much will be

spent. There's rea lly no need for a debt ceiling because it simply allows the government to borrow money to pay for bills its already spent.

For this reason, the debt ceiling was usually raised without much discussion between Congress and the President. In fact, during the last ten years,

Congress increased the debt ceiling ten times -- four times in 2008 and 2009 alone. If you look at the debt ce iling history, you'll see that Congress

usually thinks nothing o f raising the debt ceiling.

Technically, the de bt ceiling is only imposed on the "Statutory Debt Limit," which is the outstanding debt in U.S. Treasury notes adjusted for

unamortized discounts, very old debt, debt held by the Federal Financing Bank and guaranteed debt. This amount is just a little less than the total

outstanding debt recorded by the national debt clock.

Why the Debt Ceiling Matters

The debt ceiling is kind of a last resort that can be used if the President and Congress can't agree on fiscal policy. This occurred in 1985, 1995-1996,

2002, 2003, 2011 and most recently in 2013.

This can happen because elected officials have a lot of pressure to increase the annual U.S. budget de ficit, pushing the national debt higher and

higher. That's because there is very little natural incentive for politicians to curb government spending. They get re-elected for creating programs that

benefit their constituency and the ir donors. They also s tay in office if they cut taxes. Deficit spending does, in gene ral, create economic growth.

The debt ceiling, and government spending, usua lly only become a concern if the debt to GDP ratio gets too high -- above 90%. Then debt owners

become concerned that a country can't generate enough revenue to pay the deb t back.

What Happens If the Debt Ceiling Isn't Raised?

As the debt approa ches the ceiling, Treasury can stop issuing Treasury notes, and borrow from some retirement funds (but not Social Security or

Medicare). Normally, it can w ithdraw a round $800 billion it keeps at the Federal Reserve bank. Between 2008-2010, the Fed vastly increased the

amount of Treasury notes it held, a policy known as Quantitative Easing. Congressman Ron Paul (R-Texas), Chair of the Fed Oversight Committee, has

suggested that the Fed could forgive the $1.6 trillion in debt it ow ns. This would postpone the need to raise the debt ceiling.

Once the debt ceiling is reached, Treasury cannot auction new Treasury notes. It must rely on incoming revenue to pay ongo ing Federal government

expenses. This happene d in 1996, and Treasury announced it could not send out Social Security checks.

Competing Federal regulations make it unclear how Treasury could decide which bills to pay, and which to delay. Owners of the debt would get

concerned that they may not get paid.

If Treasury did actually default on its interest payments, three things would happen. First, the federa l government could no longer pay any its

employees' sa laries or benefits. All those re ceiving Social Security, Medicare, and Medicaid payments would go w ithout. Federal buildings, and services,

would close. Second, the yields of Treasury notes sold on the secondary market would rise. This would create higher interest rates, increasing the cos t

of doing business and buying a home. This would s low economic growth. Third, foreigners w ould dump their holdings. This wou ld cause the dollar to

plummet, probably removing its status as the w orld's reserve currency. The standard of living in America would decline. This w ould make it highly

unlikely that the U.S. could ever repay its debt. For all these reasons, Congress shouldn't monkey around with raising the debt ceiling. If members are

concerned with government spending, they should get serious about adopting a more conservative fiscal policy long before the debt ceiling needs to

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The U.S. debt is financed

with Treasury notes.

Photo: U.S. Department of the

Treasury 

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be raised.

The 2013 Debt Ceiling Crisis

On September 25 2013, Treasury Secretary Jack Lew warned that the debt ceiling would be reached on October 17. Many Republicans said they would

only raise the ceiling if funding for Obamacare were taken out of the FY 2014 budget. At first, it looked like House Speaker John Boehner would pass a

debt ceiling override without them. He doesn't want Republicans to be blamed for another fiasco like the 2011 debt ceiling crisis. For more, see

Congress Has Six Weeks to Avoid Debt Ceiling Crisis

However, on September 20 Boehner changed his mind. He promised to defund Obamacare, by any means necessary -- whether it meant the budget or

the debt ceiling would be held hostage. Another crisis was underway. For more, see Five Reasons Why the Move the Defund Obamacare Is Daft.

On October 1, 2013, Congress allowed a Federal government shutdown because no funding bill had bee n approved. The Senate wouldn't approve a

bill that defunded or delayed Obamacare. The House wouldn't approve a bill that funded it. Boehner announced he wouldn't raise the debt ceiling

unless Democrats agreed to negotiate cuts inmandatory programs, such as Medicare, Medicaid and Obamacare. President Obama and Senate Leader

said they'd be happy to negotiate a budget once the House approved a funding bill and raised the debt ceiling. This made it more likely that Congress

won't approve an increase in the debt ceiling.

Earlier that year, in January, Congress used the threat not raising the debt ceiling to force the Federa l government to cut spending in the FY 2013

budget. Its position was that one dollar of spending should be cut for every dollar the debt ceiling was raised. President Obama replied he would not

negotiate, since the debt was incurred to pay bills that Congress already approved. Fortunately, better-than-expected revenues meant the debt

ceiling debate w as postponed until the fall.(Source: Atlanta Blackstar, Debt Ceiling Postponed, January 23, 2013)

2011 Debt Ceiling Crisis

In 2011, Congress learned that threatening to NOT raise the debt ceiling was a poor way to manage the budget. The uncertainty surrounding this

crisis was one reason the bond rating agency Standard and Poor lowered the U.S. credit from AAA to A in August 2011. This caused the stock market

to plummet.

As a result, Congress raised the debt ceiling in early August by passing the Budget Control Act. This allowed the debt ceiling to be raised to $16.694

trillion, which the U.S. was quickly approaching as of August 31, 2012. That's when the tota l debt exceeded $16 trillion, although the sta tutory debt

subject to the debt limit was only $15.976 trillion.

The Act also required a Congressional Committee to suggest ways to reduce spending. The Simpson-Bowles Report developed a lot of good

suggestions to reduce the debt, but neither Congress nor the P resident adopted it. Instead, a set o f mandatory tax increases and spending cuts,

known as the fiscal cliff , were enacted to take p lace on January 1, 2013. Congress a voided the fiscal cliff by passing the American Taxpayer Relief Act.

It reinstated the 2% payroll tax, and postponed the budget cuts, known as sequestration, to take place on March 1 2013. For more, see Fiscal Cliff 

2013. Article updated October 7, 2013

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