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Up Front

The Hutchins Center Explains: The debt limit

Sage Belz and David Wessel

The recurring need to lift the ceiling on overall U.S. Treasury borrowing – currently set at $19.8 trillion – is always a political hot potato. Here’s what you need to know to understand the debt-ceiling debate. 

 

What is the debt limit, and why do we have one? 

When the federal government runs a deficit—that is, spends more than it collects in revenue—it borrows money to cover the difference, usually by issuing IOUs in the form of U.S. Treasury securities. The debt ceiling is a legal limit on the amount of borrowing the Treasury can do.

Before 1917, each loan issued by the Treasury required authorization from Congress. When the U.S. decided to enter the World War I, however, Congress changed the law to allow the Treasury to sell war bonds (Liberty Bonds) as needed, provided that bond sales didn’t exceed a specific amount–the debt limit.

Authors

Sage Belz

Research Assistant - Hutchins Center on Fiscal and Monetary Policy

Over the last three decades, the limit has precipitated political battles during which legislators have used the vote on the debt ceiling to try to slow the growth of federal spending. In 2011, an impasse was resolved when President Obama and Congress agreed on the Budget Control Act, which raised the debt ceiling and set limits on future spending. By October 2013, federal borrowing had reached the level provided under that act. Over the next two years, Congress enacted a number of bills that temporarily suspended the ceiling, the most recent being the Bipartisan Budget Act of November 2015. That suspension expired in March 2017, when Congress raised the limit to $19.8 trillion. Since then, Treasury has borrowed up to the limit – but no further.

Does raising the debt ceiling allow the government to spend more money? 

Raising the limit does not authorize the government to increase spending beyond the level Congress has approved.  Rather, it allows the government to meet its existing obligations to citizens, to vendors and to investors.

What happens when Treasury hits the debt ceiling?

 First, the Treasury employs a series of cash-saving tools known as “extraordinary measures.” These maneuvers suppress the level of intragovernmental debt (Treasury securities held by other government agencies) in order to create space for public debt. One way to achieve this is by suspending the daily reinvestment of government funds. When the federal government sets up a fund—for retirement plans, currency exchange or other government transactions—it invests a portion of that fund in special Treasury securities that mature and are reinvested on a daily basis. Preventing that reinvestment lowers Treasury’s total amount of debt and allows it to legally issue debt to the public once again. Suspending reinvestment of the G Fund (a retirement fund for Federal employees), for example, immediately frees up $225 billion in debt with which Treasury can raise cash and pay bills.

Extraordinary measures buy time, but aren’t large enough to prevent the government from reaching the debt ceiling indefinitely. Treasury has relied on extraordinary measures since March of this year when the suspension of the limit expired. But the Congressional Budget Office has estimated these measures will only generate enough cash to last the Treasury until mid-October, at which point the department will be truly “out of cash”– unless Congress raises the debt limit.

What does it mean for the Treasury to run out of cash?

Every day, the Treasury collects revenues from taxes and pays its bills–everything from Social Security benefits to utilities in federal buildings to interest on the debt.  When expenses exceed revenues, and the Treasury cannot increase its borrowing because of the debt ceiling, it can cover expenses only to the extent that there is cash coming in. Holding the limit at its current level would cause the Treasury to run out of cash starting sometime in the fall of 2017.  There will be enough money coming into the Treasury to pay some – but not all – of the government’s bills and obligations.

Why is raising the debt ceiling so controversial?

 The debt limit—although technically unrelated to the level of government spending—has become a flash point for debate about the size of the federal budget. Politicians who want to reduce deficits or restrain the size of government have used the debt limit to negotiate for spending caps or budget restrictions in the past, a tactic that has proven difficult but successful on occasion, as it was in 2011.

Some view “fiscal brinksmanship” as irresponsible, and argue that raising the limit ought to be routine. Many note that Congress has lifted or suspended the limit 84 times since its establishment, after all, and ought to do so freely in accordance with Treasury’s needs. Others, including a number of former Treasury secretaries from both sides of the aisle, have argued for abolishing the limit altogether. Voices in this camp claim the limit imposes unnecessary costs on taxpayers, puts the solvency of the US government at risk, and does little to rein in federal spending.

What if Congress doesn’t act?

Unable to pay all its bills and meet all its obligations, the Treasury would have to choose which ones to pay. Failure to pay Social Security or other benefits on time would have obvious political ramifications. A failure to make interest or principal payments on time – a default – is likely to damage the way the markets view U.S. government debt, perhaps increasing the interest rates that investors demand when they buy Treasury bonds. But Congress has never failed to act in time, so no one knows with certainty what the consequences would be. 

Recently released transcripts from an August 2011 Federal Open Market Committee meeting reveal that officials at Treasury and the Federal Reserve planned to prioritize interest payments on the debt over other government bills in the event that Congress didn’t raise the ceiling. Their objective was to discourage investors from fleeing Treasuries and inciting volatility in capital markets. Even with the promise of interest payments, however, Fed officials noted in the meeting that a debt breach could make rolling over matured debt—a crucial part of cash flow—very difficult. Rollover occurs when short term securities mature but get resold or reinvested by the original owner into other Treasury securities. If investors reacted poorly enough to a debt breach, the Treasury could have a hard time finding buyers for those short term securities and in turn, would suddenly owe full maturities on a portion of its debt. In short, the debt situation could escalate very quickly depending on how investors reacted to the first breach.

As long as Congress acts, even at the last minute, is everything OK?

No. There’s evidence from the 2013 debt ceiling impasse that investors dumped Treasury securities that had maturity dates around the projected limit date. In turn, rates on those securities rose sharply and liquidity in the Treasury securities market dropped. Yields on short-term Treasury bills have already risen in response to CBO’s projected October deadline, as  investors signal they are worried about the possibility of default. Because many financial transactions rely on Treasuries for collateral and for low-risk investment, those effects ripple throughout financial markets.  Beyond that, higher yields on Treasuries have a direct cost on taxpayers because they make federal debt more expensive. A Government Accountability Office study estimated that the 2011 debt limit showdown raised Treasury borrowing costs for debt matured in 2011 by $1.3 billion.

To learn more, see:

The CBO report on the Statutory Limit

The Bipartisan Policy Center’s Interactive on the History of the Limit

The Peter G. Peterson Foundation’s analysis of what’s at stake in October

The fiscal fights of the Obama administration

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