The debate on raising the debt limit: We’ve seen this movie before.

In April, the President and Congressional Republicans agreed on a deal to cut $38.5 billion in discretionary spending from the federal budget for the remainder of Fiscal Year (“FY”) 2011, averting the threat of a government shutdown. As we have noted however, that decision was “easy” when compared with the more difficult decisions Congress and the Obama Administration face on revenue and spending priorities for FY 2012 and beyond. One event triggering these decisions is the need for the federal government to raise its debt limit. This week, Treasury Secretary Geithner notified Congress that he was taking “extraordinary measures” to fund federal operations as the United States has hit the $14.3 trillion debt ceiling and could not borrow additional funds. To avoid the U.S. defaulting on its obligations, Congress will have to vote to raise the debt ceiling, and soon. However before there is a vote to do so, Speaker of the House John Boehner (R-OH-8) and other Republicans have made it clear that they want an agreement on significant cuts in spending, while Senate Democrats and the Obama Administration want revenue increases on the table as well. And even if all sides reach an agreement, another agreement will need to be reached to fund the federal government for FY 12, set to begin on October 1st. Lurking behind all of these decisions is the threat of a government shutdown – or worse – if an agreement is not reached.

Living on borrowed time. The Federal Government has already hit the $14.3 trillion debt ceiling, as Secretary Geithner has noted in his letter to Congress. Without an increase, the United States can no longer borrow funds needed for the federal government’s operations and in addition runs the risk of defaulting on its existing debt obligations. In his letter to Congressional leaders, Geithner indicates that Treasury has secured “additional headroom” by suspending investments in federal retirement funds. However, this only will buy a limited amount of time: by August 2nd “the borrowing authority of the United States will be exhausted”. Before August 2nd, Congress must vote to raise the debt limit – something it has done repeatedly over the years. However, the decision to raise the debt limit has been tied to efforts to reduce the amount that the federal government borrows. As noted above, House Speaker Boehner has made clear the position of the House Republican majority that any reductions in borrowing must come from spending cuts. The problem is to get the spending cuts needed to make significant reductions in the debt, House Republicans could not simply focus on discretionary spending programs, as was done in the April budget deal. This only constitutes about 1/3 of the federal budget. Now it must also cut spending for mandatory programs, including Social Security and Medicare, which make up the remaining two-thirds. House Republicans, led by House Budget Chairman Paul Ryan (R-WI-1), would do this in part by cutting spending to Medicare. On the other side, a number of Democrats, including Vice President Biden and Senate Budget Committee Chairman Kent Conrad (D-ND), are leading negotiations that consider other debt reduction measures, including tax increases and the end of certain tax breaks. While the details of a final debt reduction package are not yet known, it is expected that it will include both spending cuts and revenue increases. And expect to see Social Security and Medicare somewhere in the mix too. The need to address the spending for both programs was reinforced this week when Treasury announced that the trust funds for each program will be exhausted a bit earlier than anticipated. The Medicare Trust Fund will be exhausted by 2024 and the Social Security Trust Fund will be exhausted by 2036.

How this plays out in spending decisions for FY 12. The House of Representatives is moving forward on appropriations for the 12 annual spending bills that will fund the federal government for FY 12, with discretionary spending levels of $1.019 trillion among the 12 bills. This represents a cut of $30.4 billion for discretionary spending in FY 11. However, the Senate has never agreed to these numbers. Further, Democrats argue that the $1 trillion number for FY 12, which is $30.4 billion below FY 11 levels, is too low. So now all eyes are on the debt negotiations, to see if greater numbers for discretionary spending for FY 12, and beyond, are agreed to.