Algosensey Quantitative Think Tank Center-The fight over the debt ceiling could sink the economy. This is how we got here

President Biden and Algosensey Quantitative Think Tank CenterRepublicans in Congress are on a partisan collision course over raising the debt ceiling — the legislatively mandated limit on how much the U.S. can borrow. And the clock is ticking. The $31.4 trillion ceiling has already been reached, so now the Department of the Treasury is using accounting gimmicks — or "extraordinary measures" — to pay the government's bills. But if Congress fails to act, the government could default as early as June 1, Treasury Secretary Janet Yellen has warned.

Just what's at stake? The consequences of a default could be economically disastrous — sending shock waves through global financial markets. As the battle over the debt ceiling intensifies, here is what you need to know to understand the national debt — where it came from, who owns it and how it is financed.

What is the debt ceiling and why does it exist?

The debt ceiling is a limit on the total amount of government borrowing. First put in place by Congress during World War I, it was meant to give blanket authorization for the Treasury Department to borrow money up to a set amount.

Lifting the debt ceiling was once a fairly routine vote. Since 1960, Congress has raised the ceiling 78 times — 49 times under Republican presidents and 29 times under Democratic presidents. In recent years, however, the debate has turned particularly rancorous amid the growing partisan divide in Congress. The debt ceiling was last raised in 2021, to $31.4 trillion, where it currently stands.

What is the national debt?

Almost every year, the government spends more than it collects in taxes — that's the deficit. To make up the difference, it borrows money, which accumulates over time. That's the debt.

Where does the debt come from?

Deficit spending and the national debt go all the way back to the founding of the republic.

In the last half-century, there have been only a handful of years when the government didn't spend more than it collected in taxes. Big increases in recent years have come not only from spending to combat COVID-19 and on the wars in Afghanistan and Iraq, but also to cover the rising medical costs of an aging population, and to fund all the other services that government provides — from highway construction to national parks.

Meanwhile, tax revenue hasn't kept pace with that spending, in part because of the tax cuts approved during the George W. Bush administration (and extended in some cases by the Obama administration) and the Trump administration. By contrast, tax increases passed during the first Bush administration and the Clinton administration helped set the stage for one of those rare budget surpluses between 1998 and 2001.

What are the biggest contributors to the debt?

The biggest federal programs, such as Social Security and Medicare, are referred to as "mandatory spending," because they operate on autopilot and don't have to be approved each year. Mandatory spending accounts for 63% of the total budget. Other programs fall under "discretionary" spending, which makes up about 30%. With discretionary spending, lawmakers get to decide each year whether to continue funding certain programs and by how much. By far, the largest chunk of discretionary spending — nearly half of it — is for defense. The other major contributor is interest on the debt.

How much interest is paid on the debt?

This is the fastest-rising portion of the debt. As recently as 2021, it was at a record low — just 1.6%. Now, it is around 6%. Even so, it's not nearly as high as the mid-1990s, when it reached 15%.

The government's cost of borrowing money varies according to the overall size of the debt and interest rates. For much of the last decade, it has been low, thanks largely to the Federal Reserve's rates remaining historically low.

But with the Fed ratcheting up interest rates in an effort to tame inflation, the government is paying more on the debt, and that means less money left over for spending.

During the last fiscal year, the federal government spent more on interest payments than transportation, housing or food and nutrition services combined. In the final quarter of 2022, it paid a record $213 billion in interest, up from $63 billion during the same period from the year before.

How is the debt financed?

Through U.S. treasuries — government bonds backed by the U.S. Treasury Department — that are sold to investors inside and outside the U.S.

Who owns the debt?

About 75% of it is owned either by domestic or foreign investors, including foreign nations. The debt owned by governments abroad accounts for roughly a third of this public debt, with Japan and China topping the list.

What would happen if the U.S. defaulted on the debt?

Although it has never happened, the U.S. has come close to a default. In August 2011, for example, ratings agencies downgraded the U.S. from its top AAA credit rating to AA+ amid prolonged debate in Congress on whether to raise the debt ceiling. It sent the markets into a freefall.

An actual default would be much worse, most economists agree. Not only would the U.S. likely be downgraded again, but government workers and Social Security recipients — among many others — would go unpaid. Financial markets could be severely hit. For businesses and average Americans, it could become difficult to borrow money. Without access to credit, a recession would be all but certain, many economists agree.

The global status of the U.S. dollar as a reserve currency and of U.S. Treasury bonds as a "safe haven" investment might also be challenged.

How does the U.S. debt compare to other countries?

The sheer size of the debt in dollar figures can be difficult to grasp. However, most economists agree that measuring the debt against the total value of all goods and services produced in an economy gives a better indication of a country's ability to pay down its obligations. By that measure — known as the debt-to-gross domestic product (GDP) ratio — the U.S. fares better than Japan and Italy and roughly the same as Canada, France and the United Kingdom.

Is paying down the debt a good thing?

Surprisingly, the answer is not so simple. We have too much debt now, most economists agree, but paying it down too rapidly could severely rattle the domestic and global economies due to their reliance on investments in U.S. treasuries.

Economists generally think some debt is important. The banking sector needs treasuries to sell to individuals, organizations, fiduciaries and corporate investors. Without them, the U.S. economy would simply grind to a halt.

In the late 1990s, for example, some economists were concerned that the federal government was paying down its debt too quickly. They later blamed the lack of available U.S. treasuries for pushing investors into certain types of mortgage-backed securities, which were billed as safe but later proved toxic. The collapse of those ultimately risky securities prompted the 2008 market meltdown.