Joe Biden and Republican House Speaker Kevin McCarthy have reached an agreement “in principle” to raise the federal government’s debt ceiling to $31.4 billion, potentially averting an economically destabilizing default on June 5.
Any new deal still having to go through a divided Congress, however, the risk that the Treasury Department will run out of money to cover all of its obligations remains.
Without raising the debt ceiling, the US government would default on its bills, a historic first that would likely have catastrophic consequences. Federal workers would be laid off, global stock markets would crash, and the US economy would likely fall into recession.
Related: Danger and Deja Vu: What 2011 Can Tell Us About the US Debt Ceiling Crisis
As details of the deal begin to come to light, here’s a quick guide to the debt ceiling and what it means for the U.S. government and people across the country:
What is the debt limit?
The debt ceiling is the limit on the amount of money the US government can borrow to pay for services, such as Social Security, Medicare, and the military.
Each year, the government raises revenue from taxes and other flows, such as customs duties, but ultimately spends more than it receives. That leaves the government with a deficit, which has ranged from $400 billion to $3 billion every year for the past few years. decade. The deficit left at the end of the year is finally added to the total debt of the country.
To borrow money, the US Treasury issues securities, such as US government bonds, which it will eventually repay with interest. Once the US government reaches its debt limit, the Treasury can no longer issue securities, which essentially stops a key flow of money to the federal government.
Congress is responsible for setting the debt limit, which currently stands at $31.4 billion. The debt ceiling has been raised 78 times since 1960, under both Democratic and Republican presidents. Sometimes the ceiling was briefly suspended and then reinstated at a higher limit, essentially a retroactive increase in the debt ceiling.
What happens if the United States defaults?
The United States has never defaulted on its payment obligations before, so exactly what would happen is unclear. It’s not likely to be good.
“Failure to meet the government’s obligation would cause irreparable harm to the American economy, the livelihoods of all Americans, and global financial stability,” US Treasury Secretary Janet Yellen said in a statement. letter to Congress in January.
Investors would lose faith in the US dollar, causing the economy to weaken rapidly. Job cuts would be imminent and the US federal government would not be able to afford to continue all of its services. Mortgage rates would likely skyrocket, causing the housing market to plummet.
Why is US debt so high?
US debt increases when the government spends more money or when its revenue decreases.
Throughout its history, the United States has had at least some debt. But the debt really started to grow in the 1980s, after Ronald Reagan’s huge tax cuts. Without as much tax revenue, the government had to borrow more money to spend.
During the 1990s, the end of the Cold War allowed the government to reduce defense spending and a booming economy led to increased tax revenues. But then, in the early 2000s, the dotcom bubble burst, leading to a recession. George W Bush cut taxes twice, in 2001 and 2003, and then US military campaigns in Iraq and Afghanistan increased spending by nearly $6 billion over the course of the war.
When the Great Recession of 2008 began, the government had to increase spending to bail out banks and increase social services as the unemployment rate hit 10%.
When the unemployment rate returned to pre-recession levels in 2017, a major tax cut was passed under Donald Trump. The debt grew by $7.8 billion during his tenure.
And then the Covid-19 pandemic hit. The US government passed a series of stimulus bills to offset the worst of the impacts of the pandemic which ultimately totaled $5 billion.
What are the major contributors to federal government spending?
The bulk of US government spending goes to mandatory programs, such as Social Security, Medicaid, and Medicare, which account for nearly half of the overall annual budget. Military spending represents the largest portion of discretionary spending, occupying 12% of the budget. Other major items include spending on education, job training, and services and benefits for US veterans.