The US debt ceiling deal explained: how will it affect students?

By Mansoor Iqbal, Education Writer

International news over the past few months has been dominated by the very real possibility that the world’s largest economy might default on its debt. The effect, not just on the US itself, but on the rest of the world would have been catastrophic had this occurred, but a last minute deal struck by US President Barack Obama and the US legislature (Congress) earlier this week prevented this from occurring.

If you’re not well-versed in financial jargon and the in and outs of the US economy, then you may well have found the coverage a little opaque. Clearly, something big is happening, and it seems disaster has been avoided, but when it comes to actually explaining what is going on then things get a little more complicated.

The debt ceiling…

In terms of pure numbers, the US has the highest levels of debt in the world. However, if we consider the debt in comparison to its GDP, then it seems more reasonable. At present, debt levels are the equivalent of 95 per cent of the country’s GDP, which seems like a lot, but is normal – the percentage in several European and Asian financial powerhouses is even higher.

The US is unique in one way however – it has a debt ceiling, which limits the amount of debt the US can be in at any given moment. It was in fact this self-imposed limit that brought the country to the brink of a crisis. The ceiling, which stood at $14.3 trillion before this week, was reached in May, meaning that the US could not borrow any more money.

This created a problem as, without borrowing more money, the US could not afford to pay its bills, and, in order to borrow the money it needed, the ceiling had to be raised. This, it should be noted, is a pretty standard procedure – since the mid-1960s the ceiling has been raised over 70 times, including 10 in the last decade – 3 of which have been during the Obama premiership.

This time, however, things were not so simple. For it to be raised, both houses of Congress – the House of Representatives and the Senate – need to agree. The proposal ran into problems when members of the House of Representatives (controlled by the Republican Party) refused to raise the debt ceiling, unless the President and his Democrat colleagues also agreed to commit to cutting spending in order to tackle the deficit.

It was calculated that, if no more money was borrowed, the US would run out of the money it needed to honour its financial commitments by August 2nd (having kept afloat since May by stopping payments to certain pension schemes) – defaulting for the first time in its history. Amongst other things (the United States Dollar is the world’s reserve currency) this would cause the US to lose its AAA credit rating – the highest level possible – and sink to D, which would mean that banks could no longer use US debt as collateral.

The deal…

We have, however, managed to avoid this fate, thanks to a deal with which both parties are happy (for now!). President Obama has been allowed to raise the debt ceiling by at least £2.1 trillion. $400 billion will be added instantly, and another $500 billion can be added in February at the President’s discretion. The rest hinges on the balanced budget amendment, which is a proposal to add a stipulation to the constitution which will mean that the budget could not exceed revenue or 18 per cent of national income without the approval of a super majority. If this passes, $1.5 trillion can be added to the ceiling, if not (the likelier outcome) then only $1.2 trillion. Congress must consider this bill before the end of the year.

In return, he has had to agree to a similar amount of spending cuts over the next decade. Caps on discretionary spending are estimated to save $917 billion over 10 years – Obama has pointed out these will be the lowest levels of discretionary spending since Dwight Eisenhower’s premiership in the ‘50s. These cuts will include $350 billion from defence spending.

A plan for another $1.5 trillion of cuts will be drawn up by a 12 member bipartisan committee in November this year. As an added incentive for the committee to draw up a satisfactory plan, an automatic sequester will take effect if they do not. This will see a similar amount cut savagely from spending – half from the defence budget, and the rest from sources which include education, infrastructure and Medicare (social security and Medicaid are ring fenced) – the deal is designed to be unsatisfactory to both parties to encourage them to return to drawing board.

It should be noted that such long term plans are never set in stone though, and commentators have pointed out a similar automatic cuts plan made in 1985 was simply disregarded, with Congress voting to ignore them. It only takes a vote from a future Congress of a different mindset and operating in different times to change everything. Nobel Prize winning economist Paul Krugman has criticised the deal in a piece for the New York Times , in which he says cutting spending is the worst thing you can do in the current financial climate, though Obama has asserted he was not cutting too abruptly while the economy was still fragile.

The US credit rating is still likely to be downgraded from the top level, as Standard and Poor’s, one of the big three credit rating agencies who decide such things, demanded $4 trillion in deficit reduction measures to prove Washington’s commitment.

How will this affect students?

In a fact sheet released by the White House, President Obama specifically earmarks aid for college students as crucial, which is a positive sign that education will not be the worst victim of the cuts. That there will be enough funding for presidential investment in Pell Grants, in fact, seems to be a cornerstone of the deal.

This is a positive development, as Pell Grants and student loans were areas where it was feared that substantial damage would be done. However, education was mentioned as one of the areas that would be affected if the automatic sequester took effect, which means that there is a good chance that the committee will be considering it as an area which can be cut – worrying news for universities who have already had to endure cuts at state level over the past few years.

The deal did include some less good news though. In order to keep Pell Grants safe, other forms of aid have not fared as well. LEAP grants, subsidized loans for graduate students and incentives for quick repayments for student loans have all taken a hit, as have second instalments of Pell Grants. TRIO programs, Perkins loans and the Supplemental Educational Opportunity Grant are areas which have been identified as at risk from discretionary spending cuts.

The discretionary budget also includes such bodies at the National Endowment for the Arts, the National Endowment for the Humanities, and the National Science Foundation, which are all consequently at risk from cuts. The former two have already been victims of reduced funding, and a stimulus package for the latter will run out this year, though a House of Representatives subcommittee has recently recommended that its current normal funding levels are maintained. The main fear of many is that, with not enough time to evaluate each program individually, the super committee may just advocate cuts across the board, which may prove much more damaging than if they were individually tailored.

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