Debt Ceiling Defined

 

 

 

A simple economic concept that has brought the nation to its knees, it's likely that you've already heard about the debt ceiling. But what is it, and why is it such a contentious issue?

Related articles

Mentioned in this Article

Sandy Leeds

Distinguished Senior Lecturer, Department of Finance McCombs School of Business, The University of Texas at Austin

Sandy Leeds, CFA is a Distinguished Senior Lecturer at The University of Texas at Austin. He teaches graduate level classes in the MBA program and...

About the Author

Kristen Maxwell

Digital Media Producer, McCombs School of Business

I tell stories with moving pictures and sound. Everything else is just details.

Comments

#1 Terrific post. Simple

Terrific post. Simple explanation and wonderful animation.

#2 Oversimplified and

Oversimplified and Misleading Please read further for more comments from various alumni concerned with the academic integrity of this site associated with UT Austin.

#3 Excellent explanation. Anyone

Excellent explanation. Anyone can understand.

#4 [originally posted by M.A.

[originally posted by M.A. Communications] Better Explanation Go here for a much more artful and truthful animation: http://www.youtube.com/watch?v=2tUIx5DlxaI

#5 [originally posted by

[originally posted by Anonymous] Better explanation? Did you even watch these videos? One is a simple (maybe too simple) explanation of the relationship between debt ceiling and deficit reduction, and the other is a lengthy political advertisement (for changetowin.org) about how big business robbed the little guy. Get with the program, M.A. Communications, and either remove the word "misleading" from your vocabulary, or go find out what it means.

#6 [originally posted by M.A.

[originally posted by M.A. Communications] Misleading, Yes! Leaving out the fact that the debt ceiling has been raised without political debate more than 74 times since it was enacted (and that its original purpose was to stem war spending) and concluding that the answer is to cut social services-- is indeed misleading. A better take would have been how this debate was entirely counter-productive to achieving what this country needs now: Jobs, caused largely by deregulation and criminal activity in the financial sector. The video I posted is illustrative of the causes of the global economic meltdown: de-taxing and de-regulating at the top and de-unionizing at the bottom -- all to the benefit the wealthy. This so-called debate is a ruse employed by political actors to leverage "crisis" to continue to transfer wealth from the bottom to the top. See: Naomi Klein's Shock Doctrine: http://www.naomiklein.org/shock-doctrine See also this article by Dr. Richard Wolfe, author of "Capitalism Hits the Fan" http://www.rdwolff.com/content/tale-two-lootings

#7 I love that animation and the

I love that animation and the message. I don't see that it is in anyway contradictory with what we've presented. On the contrary, one of the biggest challenges to getting our economy back on track is to tackle the difficult realities of our federal budgets. Here are some compelling (non-partisan) infographics to ponder on the issue: http://www.businessinsider.com/the-us-debt-ceiling-explained-in-8-simple-charts-2011-7#defense-and-other-expenditures-vs-social-securitymedicaidother-personal-payments-1

#8 [originally posted by M.A.

[originally posted by M.A. Communications] These infographics may be non-partisan, but I'm not sure they're objective. So much is lumped together and there's no analysis or historical perspective to them. Everything has a point of view. For example, included in Social Security and Medicare spending is "other payments to individuals". What does that include? The FAA workers recently in the news? TSA? FBI? FDA? DEA? Farm subsidies to the wealthy? What? How are the comparisons illustrated affected depression-level unemployment? What can be done to raise GDP and tax revenue by putting people back to work? See articles about these issues by Huffington Post contributor Russell Green: http://populareconomicsweekly.blogspot.com/

#9 This is just as misleading as

This is just as misleading as most of what we've seen in the media for the past few weeks. Raising or not raising the debt ceiling has nothing to do with default. It's like my credit card limit. If I want to buy a big item that goes over my borrowing limit, my purchase will not be approved. I can ask to raised my limit, or I can defer the purchase until later when I've paid off some of the outstanding balance. There is no 'default.' Life goes on and taxes still come in to the treasury. If the borrowing limit is not raised the first dibs on the money coming in goes to pay interest on the existing debt. There wouid be no default. That is just a huge scare tactic. What would have to happen is a prioritization of the money left over and likely some curtailment of government activities. (Which is what is needed in order to reduce the debt in the first place.) Continuing to use the word 'default' in conjunction with the debt ceiling is totally misleading.

#10 You make some good points;

You make some good points; your comments make sense for personal finance, but we're talking about a government. Because of this, are you so sure they'd choose to pay off existing debt over say continuing to fund the military? Also, you can't just not pay medicare/medicaid. I wouldn't put it past the government to forego paying interest on a loan to keep the ship afloat domestically. Because of the gravity of cutting activities, and the congressional inertia in the way of choosing what not to fund, it is conceivable that at least one of our loan obligations could go unpaid. Whether that would cause the U.S. lose its AAA rating, or when, is definitely up for debate.

#11 Where in the Constitution or

Where in the Constitution or federal law does it state that paying interest on the debt gets "first dibs"?

#12 Wow, it was all pretty good

Wow, it was all pretty good until the very end when the video got all political and was taking the position of the millionaires and profiteers. As an alumni of this college, I am appalled at spreading such a slanted message from a University position. I received this link via one of the alumni newsletters, and if this is the sort of stuff the University is sanctioning these days...makes me sad to be an alumnus that my school which I graduated from and worked for has changed into this.

#13 Lowering Social Security

Lowering Social Security payments is not an option. It is not an entitlement, it is money deposited into that program by working people and their employers. The Government only acts in a fiduciary manner and distributes it to those eligible to receive it. If Congress did not (and continues to) borrow from the SS fund it would not be in any financial trouble.

#14 Incorrect, the Social

Incorrect, the Social Security system will run out of current receipts (taxes from citizens) and not be able to pay it's obligations in the future. It's because the system is a ponzi scheme (just not technically a ponzi scheme because we all know how it works and it is backed by the government). The ratio of retired people collecting to working people paying taxes has shifted dramatically over the past 50 years and if HUGE changes aren't made, the Social Security system will not collect enough money to pay it's annual obligations.

#15 You are both incorrect.

You are both incorrect. Social Security is not a retirement fund and it is technically not a Ponzi Scheme. Social Security is simply a welfare program.

#16 Come on, Let's Step up the

Come on, Let's Step up the Debate As this is an academic-related website and presumably you have some education, you should back up what you say with some data. Unfortunately, I don't think you can do so truthfully (there is a lot of misinformation out there by those who would seek to privatize SS and entrust our futures to the Wallstreet figures who've shown how little they care about being honest and ethical). See, for example, this article by Congressman Bernie Sanders, which provides data from the Congressional Budget Office: http://vtdigger.org/2010/08/16/sanders-a-way-to-make-social-security-solvent-for-the-next-75-years/

#17 [originally posted by

[originally posted by Greg] Are you crazy? Of course SS and medicare have to be changed. Those prgrams were created ~ 50+ years ago, in a time when the life expectancy age in the US was ~ 70 years old and where far more peoiple were working than retired (read: young and expanding workforce). Not the case any more; life expectancy is now in the 80's and workers in15 years will not greatly outnumber retires. As for Medicare, goes without saying ....helath care costs have skyrocketed since that program was enacted and the benefits provided can no longer be supported. Benefits have to be cut ...

#18 Simple approach that says

Simple approach that says nothing about the huge waste in Federal Government that has been garanteed by baseline budgeting.

#19 Giving the only explanation

Giving the only explanation of ways to lower government spending is by not paying Social Security and Medicaid is reiterating the scare tactics used by Obama and his administration. A more balanced number of recommended alternatives to consider should have been listed. Very irresponsible and disappointing coming from the McCombs Business School!

#20 Interesting how the author

Interesting how the author goes from explaining our nation's debt to proposing a solution to pay it off without ever examining how the debt was created. Shouldn't we look at how we got into debt in the first place and try not to do that thing again - such as committing to very expensive wars without funding said wars for years on end? Discussing openly and honestly what has been charged on credit (bombs, planes, radar equipment, private armies) would be a good place to start to formulate a debt payment plan and a plan to prevent this high debt situation from happening again. Isn't that "Business School 101?" Then, if you want to cut funding for one ongoing expense, such as Social Security, to be able to afford ongoing war purchases, be honest about it. Then be sure there is actually enough money in Social Security to fund said war purchases or you could end up in the same place again, running up another huge debt.

#21 Cute video but I disagree on

Cute video but I disagree on your idea of what needs to be cut. Social Security would be in wonderful financial shape if Congress had not stolen money from it to pay other bills. The socialist lean of our government in the last decades to help everyone is not sustainable. This bubble will bust. It's just a matter of when.

#22 Let' be clear, Congress has

Let' be clear, Congress has never 'stole' money from Social Security, because there's never been 'money' in Social Security to steal!! A big misconception is that taxpayers pay into Social Security over their lifetime, the government keeps the money someplace, and then gives it back to you in retirement. That is absolutely false. The Social Security account is nothing more than IOU's from that department, it doesn't save anyone's money. What we need is something more like a 401(k) program so that when we pay Social Security taxes, it actually goes into our individual accounts and therefore is not a ponzi scheme.

#23 One of the solution in long

One of the solution in long run is to , lure people to save more, shun buying Foreign made goods, Government gives more incentive to local small businesses. More Technical Training schools, and Government cut down on defense spending, which is waste of resources. More Taxes on rich people. BAD PART IS ECONOMY & DEMOCRACY CANT GO HAND IN HAND.

#24 I liked the clever video but

I liked the clever video but hated the message at the end. With all of the waste in government, and all of the give-aways, etc, the solution should not be to cut medicare and social security. The people getting this have already paid for it. Where did the money go? There should be a gillion other things done before making cuts on old sick people.

#25 SHAME ON YOU, MCCOMBS SCHOOL!

SHAME ON YOU, MCCOMBS SCHOOL! This "publication" reveals a remarkable lack of ignorance in Economics and it should never have been included in the UT newsletter. Sadly, many Americans are misinformed by the corporate media about the origins of the deficit. It has nothing to do with social spending and everything to do with 2 unfunded wars, tax cuts and subsidies for the wealthy, and lower revenues due to joblessness. Deficits in themselves are not bad, and in fact, the government should be spending more on stimulus now. See for example: http://www.fair.org/index.php?page=4371 and http://rootsaction.org/news-a-views/154-commondreams-tax-the-rich-problem-solved

#26 Nice

Nice presentation--entertaining, even. But WHOA! That leap to cutting social security and medicare is a huge mistake, and for that reason this reviewer gives the whole thing a big thumbs down. The US in 2010 spent almost as much on defense as all the rest of the world combined. The US paid $698 billion. The second largest spender was China, which spent $119 billion (in 2007, so certainly more in 2010, but the point is still made). The US, by itself, spends 43% of the total defense expenditures made by all the nations in the world. China's defense expenditure is 7% of the world total. The US spends about 4.7% of its GDP on defense; China, 2.2%; Canada, 1.5%; Germany, 1.4%; Japan, 1%. I don't know how responsible intellectuals can ignore the cost of two wars, and the god awful hemorrhage of dollars from the treasury to the pentagon, and declare that social security and medicare must be cut or we are going to financial hell. Besides, if you want to compete with China, spend less on aircraft carriers and more on domestic projects with multiplier effects on the economy. Put everybody to work--build the purchasing power of the public. (The figures are from the Stockholm International Peace Research Institute.)

#27 You Know Better, Sandy

You Know Better, Sandy .......... I'm a UT MBA alum who has had the pleasure of taking a Finance class with Sandy Leeds. Sandy is a great guy and a great professor. This video does a really nice job of explaining that the debt ceiling and our deficit problem are really different issues. Certainly they're related, but absolutely not the same. HOWEVER - I'm sad to see Sandy point to entitlement cuts as the only fix here. What about military spending? Unfortunately Sandy is taking a very partisan position on how to fix this mess. Even worse, we all know that Sandy knows better. He's no dummy. He knows that exorbitant military spending is also part of the problem. Which means that he intentionally failed to mention it. Which pretty much eliminates his credibility with me on this issue. Sad.

#28 Editor's Note: Due to a

Editor's Note: Due to a database error, some comments have disappeared from this story. We are working to restore as many as we can. While we do monitor Texas Enterprise for spam, we do not, as an editorial policy, delete or alter comments to stories.

#29 Dear All, Amusingly, when I

Dear All, Amusingly, when I was asked to do a ONE MINUTE recording, this was intended (by me) to be apolitical. So for those of you who wanted me to address other issues…it’s not possible to solve the world’s problems in one minute. With respect to other comments, let me try to clear a few things up: 1.Our government has made commitments to make payments in the future. If we don’t pay them, it’s a default. Could we simply decide to never raise the debt ceiling again, make cuts and not “default”? No, we couldn’t. Default can be to bondholders, it can be to our citizens, our government employees or to our vendors. Our promises that have already been made are greater than our inflows that we will receive. Below, I’ve put two quotes so you can see that sophisticated market participants were concerned about the possibility of default. Fed Chairman Bernanke explained in June, “Some have suggested that payments by the Treasury could be prioritized to meet principal and interest payments on debt outstanding, thus avoiding a technical default on federal debt. However, even if that were the case, given the current size of the deficit and the uneven time pattern of government receipts and payments, the Treasury would soon find it necessary to prioritize among and withhold critical disbursements, such as Social Security and Medicare payments and funds for the military.” (Bernanke, June 14, 2011, speaking at the Annual Conference of the Committee for a Responsible Budget) Similarly, last week, SF Fed President Williams said, “However, I need to stress, even as the nation must come to terms with its fiscal problems, a federal default must be avoided. Make no mistake—the Federal Reserve doesn’t have a magic wand that will allow the economy to get through a crisis of this magnitude unscathed.” (John Williams, July 28, 2011, speaking to Community Leaders, Salt Lake City, Utah) 2.There is no one who complains about “too big to fail” and the behavior of the big banks more than I do. You should go to my blog and read it at www.leedsonfinance.com. 3.If you listened carefully, you would have heard (at the end of my one minute recording) that I said, “UNFORTUNATELY” the result of our debt problem is that we’re going to end up having to cut Social Security and Medicare. I said unfortunately because I frequently talk about the problems of wealth disparity in this country. Again, go read my blog. Even when we decide who is going to pay more in taxes (and the answer is that all of us will eventually pay more), we can’t pay for Social Security and Medicare in their current form. The present value of our unfunded liabilities for the next 75 years are approximately $30 - $60 trillion (depending on what assumptions you make). In other words, that means that in today’s dollars, we have at least $30 trillion too little to pay for these. To give you some perspective, we take in less than $3 trillion in tax revenue per year (and not all of that goes to Social Security and Medicare). On average, our tax revenue is 18% of GDP (GDP is close to $15 trillion right now). The idea that we’re going to fix these obligations or grow our way out of them is absurd. We have huge problems. (I would also tell you that the $30 trillion number is based on the “open group” assumption and that is very misleading. You will get a better picture of our situation by using the “closed group” assumption of $43 trillion.) It is also without question that cutting these programs will cause tremendous problems. If you look at the median household income, it’s close to $50K (that’s a household with approximately 1.7 people working). The median household is not able to save much with this level of income and it’s going to cause problems to cut social security. 4. If you examine the projected growth of Medicare and Social Security, we would have problems even if we cut defense spending in half. While our wars have been extremely costly, even if we cut defense spending in half (which is obviously impossible), it would not solve our problems. Below, I will reference a chart that will show this to you. 5.Finally, I would suggest that you look at the 2010 Fiscal Report of the United States Government to get a better understanding of these numbers. You can google this and you will pull it up. (If you think this is a partisan report, pull up old ones when the President Bush was in office -- they all say the same thing.) Here are some quick references: (A) On page 48, you can find the unfunded liability (even though it is minimized in this estimate) (B) On page 90, you can see that the Social Security Trust Fund has $2.3 trillion in it. This is hardly enough. This is why we have a huge unfunded liability. So one commenter is correct that we’ve spent this money, but it is incorrect to think that if we had the Trust Fund money, we’d be fine. We’d still be underfunded by trillions of dollars. (C) On page 145, you can see the historic and expected level of our spending. This chart is somewhat optimistic, because it assumes that our tax revenue (as a percentage of GDP) is going to increase far above the 18% (of GDP) level (our fifty year average). (D) On page 146, you can see the real problem – that our budget deficit will pile up and then when you factor in interest, we have a disaster. Hope this helps. Sandy

#30 [originally posted by Bernie

[originally posted by Bernie Fulks] Excellent simplified video to explain the debt and reasons why USA must reduce spending below income to pay the current interest. Since most folks do not understand the debt crises and ultimate result, I plan to present this video to various church & civic groups. Good Job!

#31 [originally posted by

[originally posted by Anonymous] I think this was an excellent explainatory video. There were not any partisian statements made. If you listen, there is no mention that entitlement programs should be cut, but it is inevitable and "unfortunate" that they will have to be cut. This is currently a fact. If you look at how the liabilities of SS and Medicare are growing, it is undoubtedly unsustainable in its current form. This is the point I believe Sandy was trying to make. Plus, it is ONE MINUTE LONG! Did you really think he is trying to slip in political views and convince the world one way or the other? Calm down and look at the stats. There is no doubt if we continue on our current path there will be trouble.

#32 Thanks Sandy, not only for

Thanks Sandy, not only for the one-minute explanation, but for the concise yet detailed response. For those interested in another perspective on the deficit, see Michael Granof's recent comments on U.S. financial woes: http://bit.ly/oQnvbp.

#33 [originally posted by David

[originally posted by David Guth] I think many are missing the point of this video. My understanding of the point is to explain a concept in layman terms in a short 1 minute video. This was accomplished and I think Sandy did a great job. The Social Security and Medicare issues have been around for decades. I remember back in my 1994 UT Economics class the professor (Morgan) talked about it as an issue and how funds were going to run out due to the number of people entering SS program vs number of people paying in (as it is a pay as you go system). I don't think Sandy is taking a stance here but merely pointing out a well known fact that has been discussed for decades. PS. Relax. "academic integrity, shame on you, etc...". Clearly there was no political agenda here and the point is to explain Debt Ceiling and Debt Growth.

#34 Interesting video -

Interesting video - straightforward and easy to understand. One minor point to clarify: the accumulated historical deficits add up to the "debt held by the public" component of the national debt. This value is $9.7 trillion as of July 31, 2011. The total debt amount ($14.3 trillion) also contains $4.5 trillion in intragovernmental holdings, which consist primarily of "trust-fund" balances. I hope the folks who have read and commented on this post will also visit my blog on Texas Enterprise (http://www.texasenterprise.org/profile/tyler-chessman); I am covering the national debt based on a book I completed earlier this year.

#35 [originally posted by M.A.

[originally posted by M.A. Communications] Thanks for posting this article. It has some good analysis. However, it, too, is misleading in terms of US Healthcare costs. While I agree with the article that it is imperative that we cut the costs of healthcare, I do not at all agree in its approach. The article primarily blames soaring healthcare costs on malpractice litigation and proposes tort reform as an answer. It neither mentions the impact of a for-profit healthcare industry (unique to the US in the developed world), which concentrates wealth to C-level executives and cuts costs everywhere else, nor the sweetheart deal to the pharmaceutical industry under Bush -- the two major factors driving skyrocketing healthcare costs. To omit any analysis of these factors is, indeed, a political stance. Tort reform, while it reduces the right of individuals to ensure professional medical care by those providers they trust and to ensure funding for the long-term costs for those who negligent doctors cripple for life, does not reduce medical costs. I challenge anyone to find a case where insurance rates have been lowered for medical providers after tort reform. No, such legislation only benefits those "at the top." who live the "good life" by denying benefits to those who need them most. I strongly urge all caring academics and citizens to watch this well-researched documentary on tort reform: http://hotcoffeethemovie.com/.

#36 [originally posted by M.A.

[originally posted by M.A. Communications] On Tort Reform in Texas. I need to re-state my earlier argument on costs, which should have been that tort reform does not result in lower medical costs (not lower insurance rates). In fact, there have generally been modest decreases in insurance rates, but these reductions have not been passed onto consumers. Rather, they created an economic boom to insurers and to a lesser extent, doctors. Let's put the eyes of Texas on our own state's tort reform results in this 2009 Study by Public Citizen. The study analyzes a range of data published by academics and federal agencies. From: "Liability Limits in Texas Fail to Curb Medical Costs" http://www.citizen.org/documents/Texas_Liability_Limits.pdf "By the measures commonly used to evaluate health care – such as cost, the uninsured rate, and access to care – Texas has regressed since its liability law took effect. Collectively, these measures show that Texas has one of the worst health care systems in the United States. Moreover, since 2003 Texas has either failed to improve or grown even worse compared to other states on almost every measure. Since the liability laws took effect: • The cost of health care in Texas (measured by per patient Medicare reimbursements) has increased at nearly double the national average; • spending increases for diagnostic testing (measured by per patient Medicare reimbursements) have far exceeded the national average; • the state’s uninsured rate has increased, remaining the highest in the country; • the cost of health insurance in the state has more than doubled; • growth in the number of doctors per capita has slowed; and • the number of doctors per capita in underserved rural areas has declined. The only improvement in Texas since 2003 has been a decline in doctors’ liability insurance premiums. But payments by liability insurers on behalf of doctors have dropped far more than doctors’ premiums. This suggests that insurers are pocketing more of the savings than they are passing to doctors." It's also worth looking into data on the effects of lowering "defensive medicine" costs, which widely show that they account for less than 1-3% savings to medical COSTS. See, for example, "Low Costs Of Defensive Medicine, Small Savings From Tort Reform, (published in the policy journal, "Health Affairs") http://content.healthaffairs.org/content/29/9/1578.abstract: "The study found the savings associated with a 10 percent reduction in medical malpractice premiums would be 0.132 percent."

#37 [originally posted by M.A.

[originally posted by M.A. Communications] NOTE: See "Thanks Sandy..." by David Gregor. These notes were in response to the link posted there.

#38 [originally posted by Byron

[originally posted by Byron Enis] If you thought THIS one was bad, you should see the ridiculous partisanship at work on this one: http://texasenterprise.org/article/seasonally-adjusted That guy is advocating laying-off working-class mass-transit workers as if it was no big deal, just the way things work. It doesn't even go into detail about how the unionized bus drivers use collective bargaining to secure their livelihoods-- just an off-the-cuff remark in the middle of a manifesto supposedly about the manipulation of economic data. This "publication" is full of "well-reasoned ideas" and "real-life examples" of these supposed business terms!

#39 I was mildly enjoying Kristen

I was mildly enjoying Kristen Maxwell's video explaning the debt ceiling, etc. until I got to the part about debt reduction being a simple matter of cuts to Social Security and Medicare. Really? Just like that? Nothing about ending subsidies for the oil industry or reducing military expenditures or raising revenue on the wealthiest Americans? Let me guess, you can't do that last thing because it will interrupt all that "job creation" that's been going on for the last decade or so. I hope UT business students are getting more nuanced explanations of our country's challenges than Mr. Maxwell's. There's simple and then there's, well... simple. Eric Bartels (UT, Journalism, '82)