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The Debt Ceiling: Its Impact & Potential Issues

July 21, 2011 Written by: Written by Kevin Frankovich, CGR Associates

Currently there’s much discussion about the debt ceiling and the need to raise the current limit before the August 2nd deadline.

Over the course of the past ten years, the combination of major spending increases and reductions in revenue has resulted in our country needing to take on more debt in order for government to meet its financial obligations. Recent debate concerning the debt ceiling seems to be entwined around trying to balance two equally unfavorable remedies: deep cuts to popular government programs and major tax increases.

I’d argue that a more critical issue is what happens if there is no increase. The consequences of failure to raise the debt ceiling could potentially be paralyzing.

According to the Congressional Budget Office (CBO): “If the U.S. Treasury were precluded from borrowing due to a binding debt limit in times when federal outlays outpaced revenues, the government would no longer meet all its legal obligations in a timely manner.” Essentially, the Government would become unable to issue new debt to manage cash-flows or to finance an annual deficit, rendering it incapable of obtaining the cash needed to pay its bills.

Consequently the government would likely have to lay off workers. Private companies may soon follow. The government may also stop paying military salaries, other federal employees, and unemployment insurance. In this scenario unemployment would surge and the government would not have financial means to solve the problem.

Should the government default on its debt, interest rates would be driven to extremely high rates to finance future deficits. This could push up the price of all commodities, including oil.

Furthermore, as reported by the Congressional Research Service (CRS) in April 2011, “the government could delay or even stop paying interest on its debt which would trigger a default and risk serious negative repercussions for economies and financial markets around the world. The U.S. government’s reputation in capital markets would be compromised and raise the costs of federal borrowing in the future.”

If the debt ceiling is not increased, federal contractors could be seriously affected. The government may delay payments to borrowers, vendors, contractors, beneficiaries, state and local governments, or employees. In some cases, as with contractors, interest could accrue as a result of the Prompt Pay Act. This could put contractors in a precarious position because they would still be liable for their responsibilities, such as wages, insurance, and rent.

The debate continues and the deadline approaches. It remains to be seen whether a solution will be presented, and what impact the actions of our Congressional leaders will have on contractors and the country as a whole.