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  • Written by Steven Pressman, Professor of Economics, Colorado State University
Treasury Secretary Mnuchin is taking 'extraordinary measures' to avoid busting the debt ceiling. AP Photo/Jose Luis Magana

Editor’s note: The U.S. government maxed out its national credit card in March and has been moving money around ever since to avoid running out of cash. Very soon the Treasury Department will reach the limits of this financial sleight of hand, and Congress will have to either raise the debt ceiling – currently US$22 trillion – or suffer the consequences. Economist Steve Pressman explains why we have a ceiling and why it’s time to abolish it.

1. What is the debt ceiling?

Like the rest of us, governments must borrow when they spend more money than they receive. They do so by issuing bonds or IOUs that promise to repay the money and make regular interest payments. Government debt is the total sum of all this borrowed money.

The debt ceiling, which Congress established a century ago, is the maximum amount the government can borrow. It’s a limit on the national debt.

2. What’s the national debt?

Currently, U.S. government debt is $22 trillion, a little more than the value of all goods and services that will be produced in the U.S. economy this year.

Around one-third of this money the government actually owes itself. The Social Security Administration has accumulated a surplus and invests the extra money, currently $5.8 trillion in government bonds. The Federal Reserve holds about $2.1 trillion in U.S. Treasuries.

The rest is public debt. As of last May, foreign countries, companies and individuals owned $6.5 trillion of U.S. government debt. Japan and China are the largest holders with about $1.1 trillion each. The rest is owed to U.S. citizens and businesses, as well as state and local governments.

3. Why is there a borrowing limit?

Before 1917, Congress would authorize the government to borrow a fixed sum of money for a specified term. When loans were repaid, the government could not borrow again unless authorized to do so.

The Second Liberty Bond Act of 1917, which created the debt ceiling, changed this. It allowed a continual rollover of debt without congressional approval.

Congress enacted this measure to let then-President Woodrow Wilson spend the money he deemed necessary to fight World War I without waiting for often-absent lawmakers to act. Congress, however, did not want to write the president a blank check, so it limited borrowing to $11.5 billion and required legislation for any increase.

The debt ceiling has been increased dozens of times since then. The last change occurred in February 2018 when Congress suspended the limit until March 1, 2019. The new ceiling became the debt outstanding on that day, in the amount of $22.03 trillion.

4. What happens when the US hits the ceiling?

The U.S. government generally spends more than it takes in – $900 billion more in fiscal year 2019. Since March 1, borrowing to make up the difference is not possible. The government can spend only its cash on hand and its tax revenues.

Treasury Secretary Steven Mnuchin is now using “extraordinary measures” to conserve cash. One such measure is temporarily not funding retirement programs for government employees. The expectation is that once the ceiling is raised, the government would make up the difference.

As of July 15, the Treasury had $223 billion in cash – down from $264 billion at the start of the month. It is unclear how long this money will last. Expenditures and revenues fluctuate considerably; $200 billion can disappear in a matter of weeks.

The Bipartisan Policy Center fears that the U.S. could run out of cash in early September, although the country’s coffers may be empty even earlier. With Congress scheduled to take its annual August recess beginning July 26, something needs to be done soon.

If the cash is gone, decisions will have to be made about who gets paid with daily tax receipts. Government employees or contractors may not get paid in full. Loans to small businesses or college students may stop.

When the government can’t pay all its bills, it is technically in default. Some pundits have claimed that a government default would have dire economic consequences – soaring interest rates, markets in panic and maybe an economic depression.

Such fears seem overblown because once markets start panicking, Congress and the president usually act. This is exactly what happened in 2013 when Republicans sought to use the debt ceiling to defund Obamacare.

But we no longer live in normal political times. The major political parties are more polarized than ever. Earlier this year we endured the longest government shutdown in history over federal government spending priorities.

President Donald Trump wants the debt ceiling raised so that he can push his spending priorities for the next fiscal year, which include the military, border security and the border wall. Democrats also want to increase spending but in areas where Republicans want to see cuts: housing, education and the environment.

China is one of the biggest holders of U.S. Treasuries.AP Photo/Andy Wong

5. Is there a better way?

The U.S. is one of few countries with a debt ceiling. Other governments operate effectively without it. America could too.

Having a debt ceiling is dysfunctional. It makes it harder for the Treasury to pay bills when they come due.

The best solution would be to just scrap the ceiling altogether. Congress already approved the spending and the tax laws that require more debt; it shouldn’t have to approve the additional borrowing as well.

It should be remembered that the original debt ceiling was put in place because Congress couldn’t meet quickly and approve needed spending to fight a war. In 1917 cross-country travel was by rail, requiring days to get to Washington. This made some sense then. Today, not so much.

This is an updated version of an article originally published on July 19, 2017.

Steven Pressman does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.

Authors: Steven Pressman, Professor of Economics, Colorado State University

Read more http://theconversation.com/the-dysfunctional-debt-ceiling-and-why-we-should-kill-it-5-questions-answered-120395