Federal borrowing is once again near the statutory debt limit. At the end of last year, Secretary of the Treasury Timothy Geithner notified Congress that the $16.394 trillion limit had been reached and that his department would begin taking “extraordinary measures” to postpone the date of a potential default. Geithner estimated that the measures would create approximately $200 billion of additional room under the debt limit.
Projections by the Congressional Budget Office have also concluded that the debt limit will soon be exceeded. Prior to enactment of the “fiscal cliff” legislation, CBO estimated that the debt limit would need to be increased by mid-February or early March. A recent Bipartisan Policy Center analysis reached a similar conclusion.
A statutory increase is likely to be considered over the next two months, as Congress also attempts to pass appropriations to fund the government for the remainder of the fiscal year and address “automatic” spending cuts (the sequester) now scheduled to take effect in March.
There should be no delay in voting to increase the debt limit. Despite its name, the debt limit has never proven to be an effective means of controlling debt. And yet, failure to raise the debt limit risks serious long-term harm to the nation’s creditworthiness. The main flaw is that debt limit debates commonly take place long after decisions have been made on the policies that produce the debt. This disconnect between inputs and results gives the debt limit an arbitrary nature, which is made worse by the fact that it has never been tied to an economically significant target such as the debt-to-GDP ratio.
Current circumstances require a prompt increase in the debt limit. Reforms should then be enacted as part of a fiscal sustainability plan that tie future increases to policy decisions or economic circumstances at the time they occur.
II. What Should Policymakers Do?
A. Increase The Debt Limit
The Concord Coalition has long advocated a comprehensive fiscal sustainability plan that stabilizes the debt as a percentage of the economy and then gradually reduces it. Prompt enactment of such a plan would strengthen the economy, save future generations from an unsustainable debt burden, and protect the nation’s security.
Achieving such a plan will require tough negotiations over specific spending and tax policy options that can get the job done. They should not be over the government’s ability to pay for obligations it has already incurred.
Congressional 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 effective way to control the debt. All of the same obligations would still accrue. The only change would be to compel a default on commitments that result from past policy decisions. Such a default could potentially include Social Security, Medicare and veterans benefits, vendor payments, tax refunds, student loans and interest payments on outstanding debt.
There is no established “prioritization” process for the government to decide which bills to pay and which to ignore. It has always been assumed, for good reason, that the United States of America would pay its bills. Refusing to pay some or all of its bills would not be an act of fiscal responsibility; it would be turning the federal government into a deadbeat.
The consequences for government finances, the economy and financial markets would be dire as investors could no longer count on U.S. bonds being the “safest investment in the world.” Delaying a debt limit increase that is both necessary and inevitable would do nothing more than confirm the political dysfunction that already threatens the nation’s credit rating.
There is no fiscal need for such risk-taking behavior. Stabilizing the debt and bringing it down to a sustainable level do not require that it be frozen at some arbitrary nominal amount. In a growing economy anything measured against the size of that economy can grow in dollar terms even if it shrinks as a percentage of GDP. Thus, following World War II the debt in 1946 was $242 billion and 109 percent of GDP. By 1974, the debt had grown in dollar terms to $344 billion but had shrunk to 24 percent of GDP -- the post World War II low.
Moreover, no plausible set of policy options has been proposed for preventing a breach of the current debt limit. Budgets proposed by both President Obama and House Republicans last year would have required a substantial increase in the debt limit. The same is true of the model bipartisan plans recommended by the Simpson-Bowles commission and the Domenici-Rivlin task force.
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.
The “fiscal cliff” legislation recently signed into law by the President illustrates the problem of making policy decisions without regard to their effect on the debt limit. The Congressional Budget Office estimates that the policies in that bill will increase deficits by $4.6 trillion over 10 years relative to what had been current law. And yet, no increase in the debt limit was included to accommodate the projected cost. Beyond 10 years, of course, things will get even worse as the retirement of the baby boom generation continues.
Under these circumstances, the case for an immediate increase in the debt limit is clear; refusing to raise the debt limit would not prevent an accumulation of unpaid bills, and the resulting damage to the nation’s creditworthiness from a default would be severe. To effectively address the real fiscal threat, Congress and the President must move quickly to put the federal budget on a more responsible course by changing the underlying policies that are producing an unsustainable debt.
B. Enact a Fiscal Sustainability Plan
The fiscal cliff deal left much to be done and policymakers must get to the unfinished business swiftly. The slow-moving wheels of “regular order” seem unlikely to move fast enough.
With an unnecessary crisis over the debt limit averted, Congress and the President should promptly develop a comprehensive, specific and credible plan to place our nation on a sustainable fiscal path. Lawmakers should consider the entire federal budget to be on the table -- including entitlement programs, domestic discretionary spending, defense spending, and revenues.
The immediate fiscal goal should be to stabilize the debt-to-GDP ratio within the 10-year budget window, if not sooner. No procedural mechanism to control the debt will work if the policies don’t add up. And until an overall framework is agreed upon, it is likely that policy decisions will continue to be driven by short-term crisis management rather than responsible strategic planning. Without such a framework, economic uncertainty will continue, public frustration with the political process will grow and the debt burden hanging over future generations will remain as our legacy.
C. Develop a More Effective Approach to Raising the Debt Limit
As part of a comprehensive fiscal sustainability plan, the President and Congress should consider a more effective approach to limiting debt. The current approach does nothing to constrain fiscal policy and is not even intended to be a true "limit." It leaves the President and Congress with no choice but to raise the limit when it is reached.
In a 2011 report, the Government Accountability Office (GAO) raised concerns about the current approach in which decisions that create the need to borrow are made separately from decisions to increase the debt limit. GAO concluded that since the debate generally “occurs after tax and spending decisions have been enacted into law, Congress has a narrower range of options to effect an immediate change to fiscal policy decisions and hence to federal debt.”
In GAO’s view, improving the link between fiscal policy decisions that increase the debt and changes in the debt limit could improve the situation by helping to avoid the uncertainty and disruptions inherent in the current process. These reforms could “facilitate efforts to change the fiscal path by highlighting the implications of these spending and revenue decisions on debt,” according to GAO.
In light of these concerns and the disruption that has been caused by the current process, Congress should more closely align debt limit increases with the fiscal policy decisions that create a need for more borrowing.
There is no question that the need to raise the debt limit provides an opportunity to assess prior fiscal decisions and make corrections. Major increases in the limit have often been accompanied by the enactment of deficit reduction plans; examples include the November 1990 increase of $915 billion, the August 1993 increase of $530 billion, and the August 1997 increase of $450 billion. The 2010 law raising the debt limit also reinstituted statutory pay-as-you-go (PAYGO) rules and prompted the President to create the bipartisan National Commission on Fiscal Responsibility and Reform (Simpson-Bowles). Most recently, the Budget Control Act of 2011 (BCA) established new spending caps and created a process for achieving additional deficit reduction.
In the absence of such linkages, 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 has not, by itself, been a fiscal firewall, in the absence of more effective mechanisms it has been one of the few budgetary “speed bumps” left to provide a sense of fiscal discipline.
In the current situation, however, policymakers have other options available to exercise such discipline, including through debate on whether to prevent sequestration under the BCA, and the expiration of the continuing resolution that is currently funding government agencies.
Moreover, other means could be adopted in the future to highlight concerns about the growing debt and provide an opportunity for action. For example, the congressional budget resolution could be used to expedite consideration of a measure increasing the debt limit by the amount specified in the budget resolution. A separate vote could be required on raising the debt limit to accommodate the budget resolution policies. If the vote failed, the result would defeat the budget resolution, not risk a default on current obligations.
Alternatively, Congress could require that a debt ceiling increase be included in any bill that is estimated to require borrowing that will exceed the limit. This approach was used in several laws enacted in 2008 and 2009 to respond to the financial crisis and the economic downturn.
These and other ideas should be quickly considered this year. However, there should be no mistake about the debt limit increase; we have to pay our bills.
III. History and Significance of the Debt Limit
Upon enactment of the Second Liberty Bond Act of 1917, Congress began the practice of imposing limits on specific categories of debt. As a recent Congressional Research Service report recounts, in 1939 Congress eliminated the separate limits and created an aggregate limit covering nearly all public debt.
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, $16.394 trillion, was established on Jan. 28, 2012 using procedures in the Budget Control Act of 2011.
As of December 31, total debt outstanding that is subject to the limit was only $25 million below the $16.394 trillion limit.
Debt subject to the 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, an individual investor, a foreign government or a municipal government; and (2) intragovernmental debt -- debt the government owes itself, such as money owed to 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 income tax returns, the 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 sometimes 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 December 2012, debt held by the public (subject to the limit) totaled $11.563 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, any surpluses in these accounts are “saved” for future benefit obligations. As of the end of December 2012, intragovernmental debt (subject to the limit) totaled $4.831 trillion.
Intragovernmental debt automatically increases 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 to 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 were credited to the Social Security Trust Fund in the form of special obligation Treasury bonds. In addition, the trust fund was credited with interest on its balance in the form of additional bonds. As Social Security surpluses grew, so did the Social Security Trust Fund, and intragovernmental debt increased.
Thus, unlike debt held by the public, the 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.
IV. What Has Been 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 Treasury Department reported that total debt subject to the limit had increased by $4.173 trillion since the end of FY 2009. Of that, $3.723 trillion (89 percent) is attributable to an increase in debt held by the public and $451 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 1998-2001 period 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 the 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.
The sharp economic downturn and the crisis in financial markets, along with various fiscal measures taken in response, are responsible for most of the recent debt buildup. These changes have led to several debt ceiling increases 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. In February 2009, the American Recovery and Reinvestment Act of 2009 raised the statutory limit to $12.104 trillion -- an increase of $789 billion. In February 2010, the limit was raised to $14.294 trillion, an increase of $1.9 trillion.
Most recently, the Budget Control Act of 2011 (BCA) included a three-step procedure that was successfully used to increase the debt limit until it reached the current $16.394 trillion limit. The BCA procedures permitted the President to raise the debt limit subject to a congressional resolution of disapproval that the President could veto.
V. What Measures Can Treasury Take to Avoid Breaching The Debt Limit?
The Treasury can employ a few financial maneuvers to avoid breaching the debt limit and defaulting on the debt. These transactions are legal but can be a source of unease among lawmakers and the public. Moreover, all of these measures 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 employees’ 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 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.
Precedent for Extraordinary Measures. During the protracted debate over the last debt ceiling increase in 2011-12, the Obama administration used several of these measures. The George W. Bush administration resorted to such tactics in 2006, 2004, 2003 and twice in 2002. The Clinton administration undertook similar measures in 1995 and 1996.
Cost to the Treasury. While these measures can delay an increase in the debt limit, the GAO has concluded that the delays result in costs to the Treasury.
In a February 2011 report, the 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.
In a July 2012 report, GAO estimated that the delays in raising the debt limit during 2011 increased Treasury’s borrowing costs by about $1.3 billion in FY 2011.
Leaders of both parties have often indulged in gamesmanship with the debt limit. The party that holds the White House, faced with the responsibility to govern, must propose an increase when necessary while the other party often feels free to oppose it. Such partisan intransigence risks damaging and unnecessary debt crises.
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 obligations -- refusing to pay the bills.
If Congress finds the vote on a debt limit embarrassing, the solution is not to risk default, but to enact more fiscally responsible policies. After ensuring we can continue to pay the bills, elected officials should get to the real policy work.