Federal Debt Limit
How much do you know about the debt limit?
Spot the myths from the facts.
Myths vs. Facts
1. Since the founding of the United States, there has always been a federal debt limit.
- The Facts: Prior to World War I, Congress maintained tight control over federal borrowing by specifying the parameters of borrowing for each individual issuance of debt. The Second Liberty Bond Act of 1917 gave the Treasury much more flexibility in managing federal debt, no longer requiring consultation with Congress for every debt issuance. It wasn’t until 1939 when Congress created the first aggregate limit on federal borrowing, which at the time was $45 billion. The Treasury Department can now borrow – in the manner it sees fit – what is needed to cover congressionally authorized spending, so long as total borrowing remains under the debt limit.
2. Debt held by the Social Security trust funds, and similar debt held by other programs within the federal government, is not subject to the federal debt limit.
- The Facts: Nearly all federal debt, including debt held by the public (any investor outside the government, such as individuals and corporations) and intragovernmental debt (which is owed from one part of the federal government to another) is subject to the federal debt limit. Of the $19.8 trillion of debt currently subject to the limit, $5.5 trillion is considered intragovernmental debt and $14.4 trillion is debt held by the public. At the beginning of 2016, the Social Security trust funds held about $2.8 billion in intragovernmental debt.
3. An Act of Congress is required to raise or suspend the debt limit.
- The level of the federal debt limit is set by law, meaning that both the House and Senate must pass legislation to make any adjustments. The president then must sign the bill for it to take effect. Lawmakers can either raise the debt limit to a specific dollar amount or suspend the limit until a particular date (setting it equal to the level of debt outstanding when the debt limit is reinstated). Under the latter approach, there is effectively no limit on federal borrowing authority until that future date.
4. The debt limit has been increased under presidents and Congresses controlled by both parties.
- Since the modern debt limit was created in 1939, it has been increased dozens of times under Republican presidents and Democratic presidents alike. Congresses with Democratic and Republican majorities have authorized these increases, both when their party controlled the White House and when it did not.
5. If Congress refuses to act on the federal debt limit, the deficit will disappear and spending will be restrained.
- The Facts: The deficit is the result of tax and spending decisions made by Congress and the president. Specifically, when policymakers authorize spending that exceeds the taxes levied on the public and other revenues, the result is a deficit. Borrowing and incurring debt are merely the tools used to finance these shortfalls. When the debt limit is reached and Congress does not take action, the Treasury will reach a point when it can no longer pay all of the bills in full and on time. If this occurs, either some payments will be delayed or the federal government will default on its obligations. But the bottom line is that no such scenario will lead to less obligations or a reduction in the deficit for the federal government. Sustainable fiscal policy and balanced budgets can only result from trade-offs and fiscal discipline, not by refusing to pay the bills when they come due.
6. Increases or suspensions in the federal debt limit are always paired with dollar-for-dollar spending cuts.
- The Facts: While legislation that increases the debt limit has occasionally been used as a vehicle for broader budget reforms, the practice has significantly diminished in recent years. After the Congressional Budget and Impoundment Control Act of 1974 provided lawmakers with a new budget process for enforcing fiscal discipline, increases in the debt limit became less politically salient. In fact, from 1979 to 1994, the House of Representatives simply increased the debt limit commensurately with each year’s budget resolution, regardless of whether that resolution called for increased or decreased spending. More recently, only once (in 2011) in the past decade has a debt limit increase been paired with significant spending cuts.
7. When the federal government reaches its statutory debt limit, it immediately defaults.
- The Facts: When the federal government reaches its statutory debt limit, the Treasury Department can make use of “extraordinary measures” to temporarily avoid default. These measures include reducing certain non-marketable debt (i.e., debt owed from one part of the government to another) and adjusting the timing of contributions to federal employee retirement accounts. The maximum duration of these extraordinary measures, however, is limited and somewhat unpredictable. At a certain point, default becomes inevitable if policymakers do not enable the Treasury to borrow the necessary funds to fulfill its obligations.
8. We cannot accurately predict the exact day on which Treasury will run out of cash and be forced to default on some of its obligations.
- The exact date that the Treasury would be unable to make all payments is inherently unpredictable. The timing is entirely dependent on the Treasury’s cash on hand, which in turn, is a byproduct of each day’s tax revenue and spending, which fluctuate dramatically. If higher-than-expected economic growth results in increased tax payments, for example, that can temporarily postpone default. Lower-than-expected revenue levels or slightly higher spending caused by an economic slowdown, conversely, could result in a default days or weeks earlier than anticipated. The inherent uncertainty surrounding the exact date of default is a key factor for policymakers to consider as they decide how to approach the federal debt limit.
9. Experts have the tools to accurately predict what will happen to financial markets if the federal government defaults on its obligations.
- The Facts: The reality is that nobody knows what would happen to financial markets if the federal government failed to meet its obligations. Such a situation would be essentially unprecedented. The market reaction to recent debt limit standoffs, however, can give some clues. According to a Government Accountability Office analysis of the 2013 debt limit standoff, investors took the unprecedented step of avoiding certain Treasury securities. Specifically, securities that matured around the date when the Treasury Department projected that it would exhaust extraordinary measures to avoid default were subject to “both a dramatic increase in rates and a decline in liquidity in the secondary market where securities are traded among investors.” This market reaction led to increased costs of borrowing for the federal government, which totaled $38 million to $70 million in 2013 alone.
10. Payments to veterans, Social Security beneficiaries, food stamp recipients, and millions of others who depend upon government programs could be delayed if policymakers fail to raise the federal debt limit.
- If the Treasury Department exhausts both its borrowing authority and cash on hand, outgoing government payments must be limited to incoming revenue. Because of the federal government’s large annual deficit, spending typically exceeds revenue on any given day. In such a situation, not all payments could be made on time and in full. It is unclear whether the Treasury Department has the technical capability (or legal authority) to pick and choose which bills it would pay. More likely, the federal government would be forced to delay payments to individuals, businesses, and other organizations, negatively affecting the economy and the lives of individuals who depend on those payments. Under any of these scenarios, the result would be the same: the federal government would fail to meet its financial obligations.
11. Crossing the debt limit "X Date" would be just like a government shutdown.
- Despite frequent confusion, crossing the debt limit “X Date” and a “government shutdown” are entirely separate events, and because of that, they have two substantially different sets of consequences. A government shutdown occurs when Congress does not pass federal appropriations bills on time. While labeled a “government shutdown,” this is actually a partial shutdown, as it only affects the portion of federal outlays known as “discretionary spending,” which is the funding that Congress approves every year. Even within that, many services that are considered “essential” (e.g., airport security) continue normal operations. Unlike the problems associated with the debt limit, a partial government shutdown does NOT risk missing key payments, such as Social Security and Medicare checks, and interest payments on the federal debt. By contrast, the debt limit establishes a ceiling on the amount of debt that the Treasury can borrow to pay the government’s bills. When the federal government’s total debt runs up against the debt limit and extraordinary measures are exhausted, the Treasury can no longer borrow additional funds. If this “X Date” arrived, the Treasury Department would be forced to default on many of its obligations (i.e., miss, temporarily reduce, or delay payments), possibly including benefits for critical programs like Social Security and Medicare. Importantly, the federal government still owes all of these financial obligations that it has committed to pay. While government shutdowns can be costly to American taxpayers and cause disruptions for the public, these lapses in appropriations have occurred somewhat regularly over the past few decades. In contrast, the federal government has not experienced a major default on its financial obligations since the War of 1812. Such an event could have disastrous economic consequences.
12. There are costs to the federal government of nearing the debt limit, even if it is raised in time.
- Recent debt limit brinkmanship has imposed significant costs on the federal government, even though in each instance, the limit has been raised before missing or delaying federal payments. Specifically, the financial market implications of nearing the debt limit have caused increased borrowing costs for the Treasury, measuring in the hundreds of millions of dollars. For example, the Government Accountability Office estimated that the 2013 delay in raising the debt limit increased government interest costs by tens of millions of dollars in just one year. These costs are ultimately borne by U.S. taxpayers. Another consequence was evident in the aftermath of the 2011 debt limit impasse, when even though no payments were ultimately missed, Standard & Poor’s rating agency downgraded the credit rating of the United States. Additionally, when Treasury is forced to use extraordinary measures to avoid default, such activities and projections consume the time of federal workers at the Treasury Department, which is not an effective use of federal resources.