The Federal Deficit and the Debt Ceiling

The deadline for the federal government to raise the debt ceiling is August 2.  If the ceiling on federal debt is not raised, the federal government will not be able to borrow money, but it still has enough revenue from the collection of federal taxes to pay parts of the debt.  If Congress decides not to raise the debt ceiling, the federal government will not be able to pay government salaries, Social Security, Medicare, Medicaid, or investor bonds in full.  

While it doesn’t seem prudent to allow the federal government to borrow more money, the consequences of not raising the debt ceiling could be catastrophic.  A sudden, 45% drop in government spending could shock the economy.  Ben Bernanke, the Federal Reserve Chairman, told the Senate it would be a “recovery-ending event”.  In 1917 when the United States entered World War I, Congress authorized the Treasury to issue long-term bonds to finance the war, but placed a limit on the amount of debt the government could incur.  That limit is known as the debt ceiling, and it has been raised repeatedly since then.  The limit currently stands at $14.3 trillion, which the government reached last May.  Through some loopholing, Secretary of the Treasury Timothy Geithner has been able to provide Congress with time to raise the ceiling.  He set the deadline on August 2.

President Obama and Speaker of the House John Bohner have crafted a deal in which federal spending would be cut by $3 trillion over the next decade and tax revenues increase by $1 trillion.  If the Democrats and Republicans can agree to increase tax revenues by one dollar for every three dollars in spending cuts, this is a good compromise.  Heavy spending cuts and lighter tax increases.

Because the United States is an aging country, the federal debt will continue to grow as transfer payments for healthcare increase dramatically.  Reducing the overall national debt seems like a pipe dream right now.  The first step is to reduce the deficit (yearly debt) to zero through economic growth and lower spending.  However, the government must be extremely careful not to overdo the taxes.  Businesses and people will have less disposable income if taxes are raised, which would likely decrease overall Gross Domestic Product (GDP).