The Debt Ceiling: What it is, and why Connecticut should care

Economists agree that failure to lift the nation’s debt ceiling would be disastrous.

Should Congress and President Obama fail to reach an agreement by Thursday — the deadline when the government contends it would run out of money — it reportedly would send economic shockwaves around the world.

But what exactly is the debt ceiling, why is its role in the latest economic crisis so crucial, and why might some of those shockwaves stemming from a potential default hit particularly hard in Connecticut?

What is the debt ceiling and where did it come from?

The federal government borrows money each year to meet its obligations, selling Treasury bonds to investors. The ceiling is the limit, set by Congress, on how much the government can borrow.

Though the cost of interest on the national debt grabs plenty of headlines, other obligations at stake include Social Security, Medicare and Medicaid, and countless other operating expenses.

Congress first established the ceiling in 1917 amid concerns about the overall price tag of waging World War I, setting a limit of $11.5 billion. It has raised the ceiling 74 times since March 1962, and 10 times since 2001.

U.S. has hit the ceiling already

Technically, the country already has bumped its head on the ceiling twice in the last year.

It reached a $16.4 trillion limit Dec. 31, a few days before federal officials averted the so-called fiscal cliff — an economic nightmare characterized by major tax hikes and budget cuts imposed simultaneously.

Congress and the president would agree shortly thereafter to suspend the ceiling temporarily.

But the ceiling returned May 19 — now slightly higher at $16.7 trillion to reflect the borrowing during the suspension — and government borrowing again had reached its limit.

The Treasury Department had been using what it calls “extraordinary measures” to juggle the country’s finances and stall for time since then. These include suspending sales of certain Treasury securities — which led one Wall Street agency to order the first credit rating downgrade in the country’s history.

And experts say this extra time runs out Thursday.

What happens when the nation runs out of cash?

No one is precisely sure because it never has happened before, but experts agree the government would have to withhold a range of payments.

Those in jeopardy include: Social Security checks, payments to health care providers and numerous government programs and services.

Donald Klepper-Smith, a veteran economist with Data Core Partners in New Haven, noted that a recent NBC-Wall Street Journal poll already showed, by a more than two-to-one ratio, that consumers believe the economy is deteriorating.

But while economists say this would shatter consumer and business confidence and weaken the economy, a potential U.S. default on payments to its investors would be devastating.

Why is a default on debt so dangerous?

Because it never has happened before, a national failure to cover debts almost guarantees a new — and long-term, if not permanent — increase in borrowing costs for the U.S. in the future.

Investors “going forward would build a risk premium into our long-term debt,” Klepper-Smith said. “That opens a can of worms nobody wants to look at.”

Because Treasury bonds and the U.S. dollar are cornerstones of the international financial system, that almost certainly means higher borrowing costs for everyone else in both the public and private sectors.

“You don’t have to have much of a problem before everything just freezes up,” said Fred V. Carstensen, who heads the University of Connecticut’s economic think-tank.

Recession would be particularly dangerous for Connecticut

A suspension of government spending, coupled with a major freeze on credit, almost guarantees a tumble back into a major recession, economists said.

And if investor confidence gets shattered as well, the impact would hit particularly hard in Connecticut.

Nearly 40 percent of the state’s income tax receipts -- more than $3 billion or almost one-fifth of the entire budget -- comes from quarterly payments rather than paycheck withholding. And the bulk of those payments are tied to capital gains, dividends and other investment-related earnings.

The biggest problem with relying on this revenue source, critics note, is that when times are bad, it shrinks rapidly, sending the state budget into violent fiscal contractions.

Taxes from quarterly payments shot up 18 percent in 2008, topping $3.1 billion. One year later they fell 27 percent, losing $900 million of their value. They would have fallen another 21 percent, or nearly $500 million more, in 2010, had Gov. M. Jodi Rell and the legislature not raised income tax rates on the wealthy.

Another shockwave in the stock markets could lead directly to tens of thousands job losses here.

Unlike previous economic downturns, the so-called Great Recession that ran from late 2007 through 2009 took a particularly heavy toll on the financial services sector as companies shed jobs to preserve bonuses for top employees.

The financial activities sector of Connecticut’s labor force employs about 129,100 people, down about 14,000 workers or 10 percent from pre-recession levels.

And that doesn’t even count all of the state’s residents who work on Wall Street, which shed over 300,000 jobs during the Great Recession.

“I think another contraction would be inevitable” in the event of a debt crisis, Carstensen said.

“Wall Street has shown it will lay off people and pull back very, very aggressively when it doesn’t know what the consequences are going to be. And this is becoming a really frightening world.”

 

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