US Debt: What Is the Debt Ceiling and How Does It Work?

The U.S. debt ceiling has dominated the news in 2023, as financial pundits predicted dire consequences if the U.S. were to exceed this Congressionally-imposed spending limit. Ultimately, disaster was averted as Democrats and Republicans came together and approved a bill to raise the limit.

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However, the discussion is likely to rear its ugly head again in the not-too-distant future. But many Americans are still unclear as to what exactly the debt ceiling is, how it works and how it might affect both the country as a whole and the average American. Here are some answers.

What Is the U.S. Debt Ceiling? Simplified

There’s no better, simpler or more direct definition of the U.S. debt limit than the single sentence provided by the U.S. Treasury itself:

An important distinction to note about the debt ceiling is that raising it does not allow for new, unbridled spending by the government. The debt ceiling only allows for spending on obligations that the U.S. government has already been authorized to pay.

What Is the Origin of the U.S. Debt Ceiling?

The U.S. has essentially always had public debt. However, the formal codification of the debt ceiling traces its origins back to 1917, with the passage of the Second Liberty Bond Act. This law was enacted to make borrowing easier during the First World War, as it allowed the Treasury to freely borrow up to the debt limit without making piecemeal requests for additional funding.

Since then, the debt ceiling has been frequently raised as U.S. government obligations have risen, particularly since World War Two and into the modern era.

What Happens If the U.S. Hits the Debt Ceiling?

Failing to raise the debt ceiling would create an economic disaster. For starters, it would mean the U.S. government would default on its already existing obligations. This would not only result in a credit downgrade, it would diminish the standing of America as a financial power throughout the world.

What Happens to You If the U.S. Hits the Debt Ceiling?

Ultimately, the effects would hit the American people as well. If the U.S. defaulted on its debt, it would have to pay higher interest rates on its financial obligations. This would not only cost the American people, it would also raise market interest rates on everything from credit cards to home mortgages to auto loans. These added costs would strain household budgets.

Further, a rising-rate environment increases the risk that the economy would tip into a recession, which could result in job losses and further economic strife for the average American.

Is Raising the Debt Ceiling a Partisan Issue?

From a 30,000-foot view, raising the debt ceiling is not a partisan issue. Both sides of the aisle want the government to continue functioning for a variety of reasons, not the last of which being the preservation of America’s top-notch credit rating. But down in the trenches, there always seems to be a political fight about raising the debt ceiling, regardless of which part is in power.

In other words, when a Republican president is in power, the Democrats like to complain that the administration isn’t being responsible with its spending. The opposite is also true, with Republicans claiming that Democrats are adding unneeded spending provisions when they hold the White House and want to raise the debt ceiling.

Compromise Is Required

At the end of the day, both sides seem to miraculously come to a “bipartisan agreement that is fair for all,” or something to that effect. As a result, both Republican and Democratic presidents have a history of raising the debt ceiling, and usually more than a few times.

In fact, according to the U.S. Treasury, Congress raised, extended or revised the definition of the debt limit 78 times since 1960, 29 times under Democratic leadership and 49 times with a Republican in the White House.

Increasing the Debt Ceiling in 2023

In 2023, Democrats and Republicans waged the same age-old war: Joe Biden’s Democratic administration insisted that the debt ceiling must be raised to protect America’s standing, while many Republicans fought back and refused to support the raise unless the Democrats made various financial concessions.

But on June 2, 2023, an “overwhelming bipartisan coalition,” in the words of the New York Times, pushed through a compromise to avoid default.

What Happens If the Debt Ceiling Isn’t Raised in 2023?

If this agreement had not been reached, the U.S. economy would have likely flown into an uncontrollable tail spin. Although slowly receding, interest rates and inflation only recently hit 40-year highs, and many economists were — and still are — predicting a recession for late 2023 or early 2024.

A U.S. debt default tossed into the mix would have amounted to throwing gasoline into the fire. Rates would have likely reversed immediately, further exacerbating deteriorating economic conditions and household pain.

But now that the debt limit has been raised, inflation and interest rates may continue falling and might even keep the U.S. economy out of a recession.

The Bottom Line

The Republicans and Democrats played their same old games regarding the debt limit in 2023, but at the end of the day, cooler heads outnumbered the extremists on both sides and a deal regarding the debt ceiling was reached. For now, Americans can breathe a sigh of relief — but it’s likely that the same old problem will return in the not-too-distant future.

If history repeats itself, however, a last-minute deal will almost certainly be reached, in spite of the arguments both for and against from both sides of the aisle.

This article originally appeared on GOBankingRates.com: US Debt: What Is the Debt Ceiling and How Does It Work?