By Paul Davidson, USA TODAY
With Tuesday's deadline to increase the federal debt nearly here, the nation is bracing for potential economic calamity. Companies are holding off on hiring and capital spending. Some investors are fleeing Treasuries and stocks and seeking refuge in cash or gold. States are putting off bond sales. The $14.3 trillion debt ceiling is the amount the government is allowed to borrow, but raising it doesn't increase the deficit. It simply gives the government the authority to pay bills Congress has authorized by passing budgets. How did such a routine ritual become so controversial? Here's a primer:
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Congressional Republicans are using the debt limit vote as a bargaining chip to win big cuts in federal spending to narrow annual deficits of more than $1trillion - shortfalls that add to the national debt. Republicans and Democrats disagree on what should be slashed and by how much, though all agree cuts are necessary. The debt, which equaled about 40% of the economy in 2008, is now about 70% and could swell to 97% by 2021, the non-partisan Congressional Budget Office estimates, if temporary tax cuts and other initiatives are extended. Such outsized red ink crimps economic growth by raising interest rates, lowering the value of the dollar and forcing big tax increases.
Q.What happens if Congress doesn't raise the debt ceiling by Aug. 2?
A: Financial markets fear that the government for the first time in history could default on the interest payments it owes bondholders, a scenario that would lead to sharply higher interest rates and market chaos. But economists say that almost certainly won't happen. More likely is that the government will pay the $29billion it owes bondholders in August and, without the ability to borrow more money, decide which expenditures it won't pay for.
Q: How would the government decide which of its obligations to fund?
A: That's up to Treasury to decide, but it hasn't revealed its plans yet. In August, Treasury expects to receive $172billion in revenue but faces $307billion in payments. Under a scenario sketched out by the Bipartisan Policy Center, the government could pay for interest on Treasury bonds, Social Security, Medicare, Medicaid, unemployment insurance and defense contractors. That would leave it with no other income for all other expenses, incuding military active duty pay and various federal departments, such as Justice, Labor and Energy. Mark Zandi, chief economist of Moody's Analytics, thinks it's more likely the government will pay bills as they come due rather than open the door to divisive political battles.
Q: What will happen to the USA's top-notch credit rating if the debt ceiling isn't raised?
A: Rating agencies indicated they're likely to lower their triple-A ratings on U.S. Treasuries by a notch if the debt limit isn't increased - even if the government avoids default by paying bondholders. If the government defaults, a bigger downgrade is likely. Standard & Poor's has gone further, saying it might drop the rating even if the ceiling is raised but Congress and the White House don't agree on at least $4trillion in spending cuts over 10 years. But in congressional testimony Wednesday, S&P said a lesser amount of reductions could be acceptable.
Q:How would failure to reach agreement by Aug. 2 affect the economy?
A: It would be another blow to the fragile recovery. A downgrade of the USA's credit rating almost certainly would prompt bondholders to demand higher interest rates on Treasuries. That, in turn, would raise rates on corporate bonds, consumer mortgages and credit cards, slowing the economy. Businesses, already cautious, would rein in spending and hiring , further damping job growth.
Q: What are the Republican and Democratic propsals to raise the debt ceiling and reduce deficit spending?
A: Both plans cut spending without raising taxes. The Republican proposal by House Speaker John Boehner, R-Ohio, would raise the debt limit and make spending cuts in two steps. The first would reduce spending by $917billion over 10 years and raise the debt ceiling by $900billion. In six months, the debt limit could be raised by another $1.6trillion in exchange for $1.8trillion in spending cuts identified by a committee of lawmakers. Senate Majority Leader Harry Reid, D-Nev., is seeking a package of $2.2trillion in cuts to offset a $2.4trillion debt-limit hike that would get Congress through next year's election.