Originally published on Jan 5, 2021. Updated on Oct 14, 2021
The federal debt limit restricts the total amount of money that the Treasury Department can legally borrow at any point in time. When policymakers authorize spending that exceeds the government’s revenues, the result is a deficit. To finance these shortfalls, Treasury must issue securities to private investors (such as pension funds or foreign governments) to make up the difference. These securities are collectively known as debt held by the public.
Treasury also owes money to other parts of the federal government (such as the Social Security trust funds); these obligations are known as intragovernmental debt. Both types of debt are subject to the same debt limit.
Although sometimes confused with each other, a default by the federal government on its financial obligations due to the debt limit is very different from a federal government shutdown. A government shutdown occurs when a lapse in congressional appropriations causes federal programs considered “non-essential” to cease operations until new appropriations laws are passed. However, federal borrowing and spending considered essential—which includes interest payments on federal debt—continue uninterrupted.
In contrast, the debt limit sets a ceiling on the amount that Treasury can borrow to cover the government’s commitments that are already owed. When Treasury can no longer borrow and exhausts other available methods to make payments, the federal government would eventually be forced to miss, delay, or reduce payments that it is obligated to make. This would call into question the full faith and credit of the United States as an entity that always meets its financial obligations.
The modern debt limit was originally created to streamline federal borrowing. Since the initial debt limit was set at $45 billion in 1939, it has been increased dozens of times under Republican presidents and Democratic presidents. Congresses with Democratic and Republican majorities have authorized these increases, both when their party controlled the White House and when it did not.
Upon hitting the federal debt limit, the Treasury Department has the statutory authority to engage in so-called “extraordinary measures” that allow the government to continue paying all of its bills in full and on time. These measures temporarily reduce certain types of debt (such as debt owed to federal employee retirement accounts), thus freeing up room under the debt limit for Treasury to borrow more from the public to raise cash and meet its ongoing obligations.
Extraordinary measures are, however, limited and thus only temporary. Once they are exhausted, Treasury only has the cash in its bank account and incoming revenues to pay its bills. Given today’s large federal deficit, this won’t be enough for long. The date on which extraordinary measures are exhausted and Treasury’s cash on hand runs out is known as the “X Date.”
Has the U.S. government ever missed a payment?
- The delivery of 4,000 checks amounting to an estimated $122 million was delayed in 1979 due primarily to technical problems at the Treasury Department. This was described by some as a “mini-default.”
- Much earlier, the U.S. government also defaulted on some federal debt following the War of 1812, in part due to inconsistent federal revenues and a fragmented federal financial system.
What have been the short-term costs of debt limit brinkmanship?
- In recent episodes, debt limit brinkmanship caused increased borrowing costs in the hundreds of millions of dollars for Treasury. For example, the Government Accountability Office estimated that the 2013 delay in raising the debt limit increased Treasury’s borrowing costs by tens of millions of dollars in just one year.
- Following the 2011 and 2023 debt limit episodes, respectively, Standard & Poor’s and Fitch Ratings downgraded the U.S. long-term sovereign credit. U.S. credit rating downgrades could further increase borrowing costs – costs that are ultimately born by U.S. taxpayers. Prolonged Treasury yield increases could lead to sustained higher interest rates across consumer and business credit too.
- Implementing extraordinary measures to avert federal default consumes the time of federal workers at Treasury, which is not an effective use of taxpayer resources.
What could be the long-term costs of crossing the “X Date”?
- Even if able to prioritize certain payments, the Treasury Department would be forced to miss, delay, or reduce payments to individuals, businesses, or other organizations, negatively affecting the U.S. economy and the lives of individuals who depend on those payments.
- Financial markets depend on Treasury securities, which are viewed as one of the safest assets in the world. A default on those securities would likely roil the markets. In 2011, Fed Chairman Ben Bernanke warned that such a default could cause a financial fallout so large that it would derail the economic recovery.
Typically, the Treasury Department, the Congressional Budget Office, and the Bipartisan Policy Center each produce an estimate of when the “X Date” will surface, but fluctuations in daily cash flows make it virtually impossible to predict in advance the exact date that Treasury will no longer be able to meet its obligations.”
If lawmakers allow the Treasury Department to exhaust both its borrowing authority and cash on hand, total outgoing payments would be limited to the amount of incoming revenue. Thus, on days when spending exceeds revenue, not all payments could be made on time and in full. While Treasury has stated that it has the capacity to continue making interest and principal payments on debt in this situation, such operations would be unprecedented and of uncertain legality. Beyond those debt payments, the situation becomes even murkier. One possibility is that all of each day’s scheduled payments would be withheld until Treasury has enough cash on hand to pay them in full. In that event, many individuals and businesses owed money by the federal government would not be paid on time.
The reality is that nobody knows what would happen to financial markets if such a scenario occurred. Some elected officials have suggested that a technical default would be avoided if Treasury paid bondholders first, though others believe that the market reaction to a U.S. failure to meet any financial obligation would be severe. The bottom line is that these risks are real. U.S. debt is frequently used by global financial markets as a form of collateral due to its history as one of the safest assets in the world. If that debt starts being priced based on our nation’s willingness to pay rather than its ability to pay, the ramifications could be catastrophic.
Although the debt limit has created leverage in budget debates, it neither reduces the federal government’s obligations nor does it affect the policies that lead to debt being accumulated, namely the tax and spending decisions made by Congress and the president. Indeed, the debt limit has manifestly failed to slow the growth of soaring federal debt. Meanwhile, the limit creates periodic crises that consume Congress’s time and cause the United States to walk right up to the edge of default.
Policymakers should ask themselves if there is a better way to enforce fiscal discipline while avoiding dangerous brinksmanship. GAO and BPC have each offered alternatives to the debt limit that would more effectively force Congress to reckon with the consequences of its tax and spending decisions without risking our nation’s creditworthiness.
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