This explainer, originally published in August 2017, was updated in March 2019, July 2021, and throughout September 2021.
The recurring need to lift the ceiling on overall U.S. Treasury borrowing—currently at $22 trillion—is always a political hot potato. Here’s what you need to know to understand the debt ceiling debate.
Former Research Analyst - Hutchins Center on Fiscal & Monetary Policy, The Brookings Institution
Senior Research Assistant - Hutchins Center on Fiscal and Monetary Policy
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. entered 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.
Over the last three decades, the limit has precipitated political battles during which some legislators have used the vote on the debt ceiling to try to slow the growth of federal spending. In 2011, for instance, 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.
Over the past several years, Congress has chosen to suspend the debt limit for a specified period of time instead of raising it by a fixed dollar amount. When a suspension period ends, the debt limit is reinstated at a level that accommodates the federal borrowing that has occurred up to then. At that point, the U.S. Treasury can and often does take what are known as “extraordinary measures” (explained below) to keep the debt subject to the limit from rising until Congress act.
In August 2019, Congress suspended the debt ceiling until July 31, 2021, at which point the limit was reinstated—triggering another round of “extraordinary measures” and calls on Congress from the Secretary of the Treasury to act. A measure to suspend the debt limit until the end of 2022 passed the House on September 20th, 2021, but nearly all Republican Senators have vowed to oppose it.
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 over $290 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 eventually. Unless Congress raises the debt limit in response to its reinstatement, the Treasury estimates that these measures will only generate enough cash to last until October 18, 2021, at which point the department will be truly “out of cash.” However, the magnitude and timing of government spending and revenues are tied to the pace of the post-COVID recovery, which remains uncertain.
The blue line in the above chart shows the federal debt subject to the limit. Congress has suspended the debt limit five times since January 2014 (the periods shaded in gray). At the end of the suspension period, the limit is reinstated at a level that covers all borrowing during the suspension period—but the Treasury must undertake “extraordinary measures” (the periods shaded in blue) to maintain the debt at the new limit until Congress raises or suspends the limit once more.
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. 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 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 already lifted or suspended the limit 87 times since it was established, 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. Others argue that forcing Congress to vote to raise the debt limit is a useful lever to impose fiscal discipline in Washington.
What if Congress doesn’t act?
Unable to meet all its obligations, the Treasury would have to choose which bills to pay. Failure to pay Social Security or other benefits on time would have obvious political ramifications. 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. Treasury Secretary Yellen has warned that running out of cash would have “absolutely catastrophic economic consequences,” triggering a financial crisis that would “threaten the jobs and savings of Americans… at a time when we’re still recovering from the COVID pandemic.” But Congress has never failed to act in time, so no one knows with certainty what the consequences would be.
Transcripts from an August 2011 Federal Open Market Committee meeting reveal that officials at Treasury and the Federal Reserve had 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 the proceeds are either reinvested by the original owner or other investors put their money into Treasury securities. If investors react 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 have to make payments 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 a 2013 debt ceiling impasse—when Congress waited until the last minute to raise the debt ceiling— 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. In fall 2017, yields on short-term Treasury bills spiked leading up to the projected limit date, as investors signaled they were 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 that matured in 2011 by $1.3 billion.