Federal borrowing is once again approaching the statutory debt limit. Earlier this month, the Department of the Treasury projected that “the United States will exhaust its borrowing authority under the debt limit on August 2, 2011.” Projections by the Congressional Budget Office and the Office of Management and Budget have also concluded that the debt limit will soon be exceeded. This brief answers common questions about the statutory debt limit and the need to increase it.
What is the debt limit and why is it important? According to the Congressional Research Service, Congress has always placed restrictions on federal debt. Prior to World War I, borrowing was often authorized for separate purposes such as military activities and the construction of the Panama Canal.
In 1939, Congress eliminated separate limits on bonds and other types of debt and created the first aggregate limit covering nearly all public debt.[1] Today, debt incurred by the Treasury continues to be subject to an overall statutory limit set by Congress. Congress has established in law the maximum amount of debt the federal government may issue. This limit has not been tied to any particular fiscal policy goal, such as keeping the debt stable as a percentage of the economy. For that reason, it has had little effect on the nation's underlying spending and tax policies.
The Treasury does not have legal authority to issue any debt above this statutory limit. To avert a default on its credit obligations or a shutdown of government operations, occasionally it is necessary to raise the limit. The current statutory debt limit, $14.294 trillion, was established on February 12, 2010. As of June 30, the debt was only $25 million below this limit.
Debt subject to limit has two components: (1) debt held by the public -- debt held by any individual or entity that is not the federal government such as a mutual fund, individual investor, foreign government, or a municipal government; and (2) intragovernmental debt -- debt the government owes itself such as the Social Security Trust Funds, the Medicare Hospital Insurance Trust Fund, and the Civil Service Retirement and Disability Fund. There is a small amount of the “total debt outstanding” that does not fall under the debt limit. That is why the numbers commonly reported as the “national debt” might at times look larger than the debt limit.
What is the debt limit and why is it important? According to the Congressional Research Service, Congress has always placed restrictions on federal debt. Prior to World War I, borrowing was often authorized for separate purposes such as military activities and the construction of the Panama Canal.
In 1939, Congress eliminated separate limits on bonds and other types of debt and created the first aggregate limit covering nearly all public debt.[1] Today, debt incurred by the Treasury continues to be subject to an overall statutory limit set by Congress. Congress has established in law the maximum amount of debt the federal government may issue. This limit has not been tied to any particular fiscal policy goal, such as keeping the debt stable as a percentage of the economy. For that reason, it has had little effect on the nation's underlying spending and tax policies.
The Treasury does not have legal authority to issue any debt above this statutory limit. To avert a default on its credit obligations or a shutdown of government operations, occasionally it is necessary to raise the limit. The current statutory debt limit, $14.294 trillion, was established on February 12, 2010. As of June 30, the debt was only $25 million below this limit.
Debt subject to limit has two components: (1) debt held by the public -- debt held by any individual or entity that is not the federal government such as a mutual fund, individual investor, foreign government, or a municipal government; and (2) intragovernmental debt -- debt the government owes itself such as the Social Security Trust Funds, the Medicare Hospital Insurance Trust Fund, and the Civil Service Retirement and Disability Fund. There is a small amount of the “total debt outstanding” that does not fall under the debt limit. That is why the numbers commonly reported as the “national debt” might at times look larger than the debt limit.
Debt held by the public. When revenues received by the Treasury are not sufficient to meet the expenses of the federal government, the Treasury borrows to obtain the cash necessary to meet its obligations. Although much of the federal revenue used to finance government operations is received in the spring when individuals file their annual income tax returns, the federal government incurs a steady stream of operating costs all year long. Consequently, to smooth cash flow and enable the federal government to finance daily operations, the Treasury borrows money by selling securities to the public. These securities comprise the debt held by the public. Debt held by the public rises and falls depending on the government’s immediate borrowing needs. It represents the cumulative amount of borrowing required to finance budget deficits. Because debt held by the public flows through financial markets, it has more immediate relevance to the economy than intragovernmental debt, which is a matter of internal bookkeeping. As of the end of June 2011, debt held by the public (subject to limit) totaled $9.722 trillion.
Intragovernmental debt. For the most part, intragovernmental debt consists of trust fund accounts that are credited with dedicated revenue such as Social Security and Medicare payroll taxes (FICA). In theory, surpluses in these accounts are “saved” for future benefit obligations. As of the end of June 2011, intragovernmental debt (subject to limit) totaled $4.572 trillion.
Intragovernmental debt increases automatically every year by the amount of trust fund surpluses invested in Treasury securities, regardless of whether the budget is in surplus or in deficit. For example, in every year from 1984 up until 2010 the Social Security program generated a cash surplus -- the federal government collected more dedicated revenues than it needed to pay current benefits. Surplus taxes are credited to the Social Security Trust Fund in the form of special obligation Treasury bonds. In addition, the trust fund is credited with interest on its balance in the form of additional bonds. As Social Security surpluses grow, so too does the Social Security Trust Fund, and intragovernmental debt rises. Thus, unlike debt held by the public, growth of intragovernmental debt does not reflect an imbalance in short-term fiscal policy. It represents a very different problem -- growing long-term obligations that future taxpayers will have to pay for when the Treasury ultimately has to transform these bonds into benefits.
What is driving the need to raise the debt limit? Unchecked growth in either category of debt will generate pressure to raise the debt limit. At the end of the last fiscal year, the Department of the Treasury reported that total debt increased by $1.652 trillion since FY 2009. Of that, $1.471 trillion (89 percent) is attributable to an increase in debt held by the public and $181 billion (11 percent) is attributable to an increase in intragovernmental debt.
To understand the role of each component relative to the debt limit, consider the brief period in 1998-2001 when four years of budget surpluses allowed the federal government to buy back, or “pay down,” $453 billion in debt held by the public. Over those same four years, intragovernmental debt increased by $853 billion (largely due to substantial Social Security surpluses credited to the Social Security Trust Fund). As a result, the total debt subject to limit rose from $5.328 trillion at the end of FY 1997 to $5.733 trillion at the end of FY 2001.
When Congress increased the debt limit in 2002 from $5.95 trillion to $6.40 trillion, debt held by the public was actually lower than it had been when the debt limit was previously increased in 1997. The limit was raised to accommodate the increase in intragovernmental debt.
Congress could avoid future trust fund-induced increases in the debt limit if it “saved” trust fund surpluses by running total, or “unified,” budget surpluses equal to the trust fund surpluses and making corresponding reductions in debt held by the public. If the increase in intragovernmental debt, which mostly represents future obligations, were offset by an equivalent reduction in debt held by the public, the budget and the economy would be better prepared to make good on those future obligations. Following this strategy, however, would require substantial budget surpluses and a degree of political cooperation and fiscal discipline that is not currently in evidence.
What is the status of Congressional legislation raising the debt limit? Congress has yet to act on legislation to raise the debt limit. According to the Treasury Department, the debt limit will be reached by August 2nd. Thus, legislation is likely to be considered in the near future.
If Congress fails to act, what are the options the Treasury has to avoid breaching the debt limit? The U.S. Treasury can employ a few financial maneuvers to avoid breaching the debt limit and defaulting on the national debt. In May, Secretary of the Treasury Timothy Geithner notified Congress that he has begun taking some of these steps. These transactions are completely legal, but they are a source of unease among lawmakers and the public. Moreover, all of these machinations merely postpone the inevitable -- an increase in the statutory debt limit.
For example, the Treasury can:
• Suspend reinvestment of government securities in federal trust funds such as the G-Fund of the federal employee’s Thrift Saving Plan (TSP) or the Civil Service Retirement and Disability Fund (CSRDF). Such action prevents this part of the intragovernmental debt from growing. Manipulating retirement funds may sound ominous, especially to federal employees, but laws enacted in the 1980s require the Treasury to restore all due interest and principal to the fund as soon as it can.
• Delay or suspend the auction of public debt instruments. This action prevents debt held by the public from growing. Individuals and institutional investors regularly purchase Treasury securities for investment purposes. The revenue from the sale of securities is then used to manage the cash flow needs of the federal government. Therefore, suspending the sale of T-bills can be very disruptive to domestic and international financial markets as well as the operations of the federal government.
In a February 2011 report, the Government Accountability Office (GAO) warned that if Treasury is forced to take extraordinary steps such as postponing auctions, resources will be diverted from other priorities, uncertainty will be added to the market, and borrowing costs could increase.
Has the Treasury resorted to similar tactics before? Yes. The Clinton Administration undertook similar measures in 1995 and 1996, and the Bush Administration resorted to such tactics in 2006, 2004, 2003 and twice in 2002.
How did we get to this point? The various fiscal measures taken to remedy the economic downturn and the crisis in financial markets are responsible for most of the recent debt buildup. These pieces of legislation caused a series of several increases to occur within a relatively short period of time. In July 2008, the Housing and Economic Recovery Act increased the debt limit by $800 billion to $10.615 trillion. In October, another addition was needed and a $700 billion increase was attached to the Emergency Economic Stabilization Act of 2008. Then, in February 2009, the American Recovery and Reinvestment Act of 2009 raised the statutory limit to $12.104 trillion -- an increase of $789 billion. Most recently, in February 2010, the limit was raised to the current level of $14.294 trillion, an increase of $1.9 trillion. The 2010 law raising the debt limit (P.L. 111-139) also reinstituted statutory pay-as-you-go (PAYGO) rules and prompted the President to create a fiscal commission.
What should Congress do? Raising the debt limit is essentially a decision to pay the bills. Conversely, refusing to raise the debt limit is essentially a decision to default on government past obligations -- refusing to pay the bills.
Political leaders of both parties have often indulged in partisan gamesmanship with the debt limit. The party in power, having the responsibility to govern, must propose an increase when necessary while the party out of power feels free to oppose it. Such partisan intransigence risks a damaging and unnecessary debt crisis.
Approval of a debt limit increase is necessary to maintain the full faith and credit of the United States government. Failure to approve an increase would not be an act of fiscal responsibility, unless it can be said that deadbeats are fiscally responsible because they refuse to pay their bills. It would result in the United States defaulting on the commitments it has already made, including Social Security, Medicare and veterans benefits, vendor payments, tax refunds, student loans and interest payments on outstanding debt.
The consequences for government finances, the economy and financial markets would be dire as investors would no longer be able to count on U.S. bonds being the "safest investment in the world." Delaying action on an increase until the last possible moment, forcing Treasury to utilize extraordinary measures to avoid a default, is unnecessary and irresponsible.
Unlike budget enforcement mechanisms such as statutory spending caps or the pay-as-you-go (PAYGO) rules for entitlement expansions and tax cuts, the debt limit places no restrictions on specific tax and spending decisions. If deficits result from these policy decisions, or if the economy fails to grow as projected, the debt limit must be increased to prevent a default on the government’s obligations.
Moreover, no plausible set of policy options have been proposed, nor do they exist, for preventing a breach of the current limit.
However, the need to raise the debt limit does provide an opportunity to assess past fiscal decisions and, if necessary, make corrections. In the past, major increases in the debt limit have often been accompanied by the enactment of deficit reduction plans such as the November 1990 increase of $915 billion, the August 1993 increase of $530 billion, and the August 1997 increase of $450 billion. In the absence of such linkage, Congress has been reluctant to raise the debt limit by more than is necessary to get through a short period of time. Thus, while the debt limit is not, by itself, a fiscal firewall, in the absence of other more effective mechanisms, it is one of the few budgetary speed bumps left to provide a sense of fiscal discipline. For this reason, both the House and Senate should debate and vote on the debt limit. If Members of Congress find it embarrassing or distasteful to vote on a debt limit increase, the remedy is to enact more responsible fiscal policies.
Congress and the President should use the need for action on the debt limit as an opportunity to develop a specific and realistic plan to put the country on a sustainable fiscal path. For example, they could use the debt limit increase as an opportunity to consider spending caps and/or tax and entitlement reform recommendations that the President’s fiscal commission and other bipartisan commissions have released. If such a plan takes time to develop, negotiate and implement, short-term increases in the debt limit could keep the pressure on without risking a default.
According to the Congressional Budget Office, President Obama’s proposed FY 2012 budget will add another $9 trillion to the publicly held debt over ten years. Under the President’s budget and the House passed budget resolution, the debt limit would need to be raised to fund the government though the end of FY 2012. Beyond then, things will get even worse as the retirement of the baby boom generation hits full stride.
Current fiscal policy is not sustainable. The rationale for confronting this problem along with a debt limit increase is clear: greater flexibility to increase the debt would be tied to enactment of a fiscally responsible budgetary framework going forward.
As part of that framework, the President and Congress should also consider a more rational approach to limiting debt such as establishing a debt-to GDP target with tax and spending triggers to enforce it. The current approach does nothing to constrain fiscal policy and, indeed is not even intended to be a true "limit." It is nothing more than a pit stop, which leaves the President and Congress with no choice but to raise the limit when it is reached.
These and other ideas should be included in the upcoming debt limit debate, but there should be no mistake about the end result. We have to pay our bills.
For More Information:
Bureau of the Public Debt
The Debt to the Penny
Raising the Debt Limit: The Department of the Treasury
Monthly Debt Position and Activity Reports
Office of Management and Budget Historical Tables
February 2011 GAO Report
Footnotes
[1]The Debt Limit: History and Recent Increases, Congressional Research Service, May 2011.
Intragovernmental debt. For the most part, intragovernmental debt consists of trust fund accounts that are credited with dedicated revenue such as Social Security and Medicare payroll taxes (FICA). In theory, surpluses in these accounts are “saved” for future benefit obligations. As of the end of June 2011, intragovernmental debt (subject to limit) totaled $4.572 trillion.
Intragovernmental debt increases automatically every year by the amount of trust fund surpluses invested in Treasury securities, regardless of whether the budget is in surplus or in deficit. For example, in every year from 1984 up until 2010 the Social Security program generated a cash surplus -- the federal government collected more dedicated revenues than it needed to pay current benefits. Surplus taxes are credited to the Social Security Trust Fund in the form of special obligation Treasury bonds. In addition, the trust fund is credited with interest on its balance in the form of additional bonds. As Social Security surpluses grow, so too does the Social Security Trust Fund, and intragovernmental debt rises. Thus, unlike debt held by the public, growth of intragovernmental debt does not reflect an imbalance in short-term fiscal policy. It represents a very different problem -- growing long-term obligations that future taxpayers will have to pay for when the Treasury ultimately has to transform these bonds into benefits.
What is driving the need to raise the debt limit? Unchecked growth in either category of debt will generate pressure to raise the debt limit. At the end of the last fiscal year, the Department of the Treasury reported that total debt increased by $1.652 trillion since FY 2009. Of that, $1.471 trillion (89 percent) is attributable to an increase in debt held by the public and $181 billion (11 percent) is attributable to an increase in intragovernmental debt.
To understand the role of each component relative to the debt limit, consider the brief period in 1998-2001 when four years of budget surpluses allowed the federal government to buy back, or “pay down,” $453 billion in debt held by the public. Over those same four years, intragovernmental debt increased by $853 billion (largely due to substantial Social Security surpluses credited to the Social Security Trust Fund). As a result, the total debt subject to limit rose from $5.328 trillion at the end of FY 1997 to $5.733 trillion at the end of FY 2001.
When Congress increased the debt limit in 2002 from $5.95 trillion to $6.40 trillion, debt held by the public was actually lower than it had been when the debt limit was previously increased in 1997. The limit was raised to accommodate the increase in intragovernmental debt.
Congress could avoid future trust fund-induced increases in the debt limit if it “saved” trust fund surpluses by running total, or “unified,” budget surpluses equal to the trust fund surpluses and making corresponding reductions in debt held by the public. If the increase in intragovernmental debt, which mostly represents future obligations, were offset by an equivalent reduction in debt held by the public, the budget and the economy would be better prepared to make good on those future obligations. Following this strategy, however, would require substantial budget surpluses and a degree of political cooperation and fiscal discipline that is not currently in evidence.
What is the status of Congressional legislation raising the debt limit? Congress has yet to act on legislation to raise the debt limit. According to the Treasury Department, the debt limit will be reached by August 2nd. Thus, legislation is likely to be considered in the near future.
If Congress fails to act, what are the options the Treasury has to avoid breaching the debt limit? The U.S. Treasury can employ a few financial maneuvers to avoid breaching the debt limit and defaulting on the national debt. In May, Secretary of the Treasury Timothy Geithner notified Congress that he has begun taking some of these steps. These transactions are completely legal, but they are a source of unease among lawmakers and the public. Moreover, all of these machinations merely postpone the inevitable -- an increase in the statutory debt limit.
For example, the Treasury can:
• Suspend reinvestment of government securities in federal trust funds such as the G-Fund of the federal employee’s Thrift Saving Plan (TSP) or the Civil Service Retirement and Disability Fund (CSRDF). Such action prevents this part of the intragovernmental debt from growing. Manipulating retirement funds may sound ominous, especially to federal employees, but laws enacted in the 1980s require the Treasury to restore all due interest and principal to the fund as soon as it can.
• Delay or suspend the auction of public debt instruments. This action prevents debt held by the public from growing. Individuals and institutional investors regularly purchase Treasury securities for investment purposes. The revenue from the sale of securities is then used to manage the cash flow needs of the federal government. Therefore, suspending the sale of T-bills can be very disruptive to domestic and international financial markets as well as the operations of the federal government.
In a February 2011 report, the Government Accountability Office (GAO) warned that if Treasury is forced to take extraordinary steps such as postponing auctions, resources will be diverted from other priorities, uncertainty will be added to the market, and borrowing costs could increase.
Has the Treasury resorted to similar tactics before? Yes. The Clinton Administration undertook similar measures in 1995 and 1996, and the Bush Administration resorted to such tactics in 2006, 2004, 2003 and twice in 2002.
How did we get to this point? The various fiscal measures taken to remedy the economic downturn and the crisis in financial markets are responsible for most of the recent debt buildup. These pieces of legislation caused a series of several increases to occur within a relatively short period of time. In July 2008, the Housing and Economic Recovery Act increased the debt limit by $800 billion to $10.615 trillion. In October, another addition was needed and a $700 billion increase was attached to the Emergency Economic Stabilization Act of 2008. Then, in February 2009, the American Recovery and Reinvestment Act of 2009 raised the statutory limit to $12.104 trillion -- an increase of $789 billion. Most recently, in February 2010, the limit was raised to the current level of $14.294 trillion, an increase of $1.9 trillion. The 2010 law raising the debt limit (P.L. 111-139) also reinstituted statutory pay-as-you-go (PAYGO) rules and prompted the President to create a fiscal commission.
What should Congress do? Raising the debt limit is essentially a decision to pay the bills. Conversely, refusing to raise the debt limit is essentially a decision to default on government past obligations -- refusing to pay the bills.
Political leaders of both parties have often indulged in partisan gamesmanship with the debt limit. The party in power, having the responsibility to govern, must propose an increase when necessary while the party out of power feels free to oppose it. Such partisan intransigence risks a damaging and unnecessary debt crisis.
Approval of a debt limit increase is necessary to maintain the full faith and credit of the United States government. Failure to approve an increase would not be an act of fiscal responsibility, unless it can be said that deadbeats are fiscally responsible because they refuse to pay their bills. It would result in the United States defaulting on the commitments it has already made, including Social Security, Medicare and veterans benefits, vendor payments, tax refunds, student loans and interest payments on outstanding debt.
The consequences for government finances, the economy and financial markets would be dire as investors would no longer be able to count on U.S. bonds being the "safest investment in the world." Delaying action on an increase until the last possible moment, forcing Treasury to utilize extraordinary measures to avoid a default, is unnecessary and irresponsible.
Unlike budget enforcement mechanisms such as statutory spending caps or the pay-as-you-go (PAYGO) rules for entitlement expansions and tax cuts, the debt limit places no restrictions on specific tax and spending decisions. If deficits result from these policy decisions, or if the economy fails to grow as projected, the debt limit must be increased to prevent a default on the government’s obligations.
Moreover, no plausible set of policy options have been proposed, nor do they exist, for preventing a breach of the current limit.
However, the need to raise the debt limit does provide an opportunity to assess past fiscal decisions and, if necessary, make corrections. In the past, major increases in the debt limit have often been accompanied by the enactment of deficit reduction plans such as the November 1990 increase of $915 billion, the August 1993 increase of $530 billion, and the August 1997 increase of $450 billion. In the absence of such linkage, Congress has been reluctant to raise the debt limit by more than is necessary to get through a short period of time. Thus, while the debt limit is not, by itself, a fiscal firewall, in the absence of other more effective mechanisms, it is one of the few budgetary speed bumps left to provide a sense of fiscal discipline. For this reason, both the House and Senate should debate and vote on the debt limit. If Members of Congress find it embarrassing or distasteful to vote on a debt limit increase, the remedy is to enact more responsible fiscal policies.
Congress and the President should use the need for action on the debt limit as an opportunity to develop a specific and realistic plan to put the country on a sustainable fiscal path. For example, they could use the debt limit increase as an opportunity to consider spending caps and/or tax and entitlement reform recommendations that the President’s fiscal commission and other bipartisan commissions have released. If such a plan takes time to develop, negotiate and implement, short-term increases in the debt limit could keep the pressure on without risking a default.
According to the Congressional Budget Office, President Obama’s proposed FY 2012 budget will add another $9 trillion to the publicly held debt over ten years. Under the President’s budget and the House passed budget resolution, the debt limit would need to be raised to fund the government though the end of FY 2012. Beyond then, things will get even worse as the retirement of the baby boom generation hits full stride.
Current fiscal policy is not sustainable. The rationale for confronting this problem along with a debt limit increase is clear: greater flexibility to increase the debt would be tied to enactment of a fiscally responsible budgetary framework going forward.
As part of that framework, the President and Congress should also consider a more rational approach to limiting debt such as establishing a debt-to GDP target with tax and spending triggers to enforce it. The current approach does nothing to constrain fiscal policy and, indeed is not even intended to be a true "limit." It is nothing more than a pit stop, which leaves the President and Congress with no choice but to raise the limit when it is reached.
These and other ideas should be included in the upcoming debt limit debate, but there should be no mistake about the end result. We have to pay our bills.
For More Information:
Bureau of the Public Debt
The Debt to the Penny
Raising the Debt Limit: The Department of the Treasury
Monthly Debt Position and Activity Reports
Office of Management and Budget Historical Tables
February 2011 GAO Report
Footnotes
[1]The Debt Limit: History and Recent Increases, Congressional Research Service, May 2011.
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