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How the Debt Ceiling Works

        Money | Economic Concepts

What Is the Debt Ceiling?

As the Daily Treasury Statement shows, the U.S. federal government spends an obscene amount of money every day to pay for hundreds of programs and services, from national defense to education to disease control and prevention.

The problem is that the federal government doesn't earn enough in income tax and other revenue to cover the cost of running the country. The result is that pesky budget deficit. Technically, Congress could erase the budget deficit by passing steep spending cuts, raising taxes or both, but that has proven politically problematic.

Instead, the government covers the budget deficit by borrowing money. The president doesn't walk down to a Bank of America and ask for a $1 trillion loan. The better way is to sell U.S. Treasury securities to individuals, banks, corporations and even foreign governments. When you buy a Treasury bond, you are essentially lending money to the government at a low interest rate. China and Japan each owned more than a trillion dollars in U.S. Treasury securities as of July 2013 [source: U.S. Treasury Dept.].

When you add up all of the money that the federal government has borrowed from other countries, individuals and even itself (the Federal Reserve owned more than $2 trillion in Treasury securities as of October 2013), you get the national debt [source: Federal Reserve]. The national debt doubled from $5.7 trillion in 2000 to $10 trillion in 2008 and now stands at more than $16 trillion [source: U.S. Treasury Dept.].

Which brings us to the debt ceiling. Some folks compare the debt ceiling to the credit limit on your credit card. If your card has a $10,000 credit limit, then you can only charge $10,000 on your card without paying down the outstanding balance. In much the same way, the debt ceiling is a limit on how much the government can borrow to pay for its programs and services.

But there are key differences between the debt ceiling and a credit limit. The bank set your credit limit because it decided that that it's too risky to lend you more than $10,000. On the flip side, the foreign governments and individuals that buy U.S. Treasury securities can't get enough U.S. debt [source: Hirsch]. To them, it's literally the most reliable investment in the world, backed by the "full faith and credit" of the U.S. government.

In the case of the debt ceiling, the credit limit is imposed by the borrower, not the lender. Congress sets the debt ceiling, not our foreign or domestic creditors. But why would Congress want to lower U.S. debt if the well of low-interest credit never runs dry? To answer that question, we first need to study the history of the debt ceiling.