QUESTION: Since the beginning of the year, the nation's debt has grown by more than $3 trillion. Isn't there supposed to be a federal debt limit and why didn't it kick-in?
ANSWER: The short answer is that the statutory debt limit has been suspended through July 2021, allowing lawmakers to borrow without legal constraints until then. A year from now, however, the debt limit will snap back to life, automatically set at whatever the debt happens to be at that time.
Because the federal government will still need to borrow huge sums to finance its existing obligations, lawmakers will once again be confronted with a crisis that could prevent the government from paying its bills, which would jeopardize the nation’s creditworthiness. While the Treasury will be able to keep the government’s total debt below the new limit by taking authorized “extraordinary measures,” these will run out within a few months.
At that point, the only options would be to raise the debt limit, suspend it once again, eliminate it, or begin defaulting on obligations. Congress and the president should use the next several months to come up with a plan that avoids any prospect of a government default.
What is the debt limit and why do we have it?
The U.S. Treasury Department explains that the debt limit is the “total amount of money that the United States government is authorized to borrow to meet its existing legal obligations, including Social Security and Medicare benefits, military salaries, interest on the national debt, tax refunds, and other payments.”
The statutory debt limit was first created in 1917, with the original purpose of removing the requirement that Congress authorize individual issuances of debt. The intent was to help ensure that sufficient and timely credit would be available to finance World War I.
This original purpose has faded from memory and practical significance. Today, many people naturally assume that the debt limit is meant to prevent the government from running up too much debt. It does not. Unlike budget process mechanisms such as caps on appropriations or pay-as-you-go (PAYGO) rules that require spending increases or tax cuts to be paid for, the debt limit places no restrictions on specific tax and spending decisions.
As explained by the Government Accountability Office (GAO), “The debt limit does not control or limit the ability of the federal government to run deficits or federal agencies’ ability to incur obligations. Rather, it is a limit on Treasury’s ability to borrow to pay bills already incurred. Under current law, the decisions that create the need to borrow are made separately from — and generally earlier than — decisions about the debt limit”.
How have lawmakers dealt with the debt limit in the past?
Throughout history, Congress has always increased the statutory debt limit to ensure Treasury had the operating cash necessary to pay the government’s bills. Since 1960, Congress has acted more than 80 times – under both Republican and Democratic administrations – to permanently raise, temporarily extend, or revise the definition of the debt limit.
Prior to 2013, Congress would increase the debt limit in straightforward fashion: by amending the dollar value of the cap as it appears in statute. As the politics of trillion-dollar deficits and commensurate increases in the debt limit became politically unpopular, however, a more nuanced solution emerged.
In recent years, Congress has adopted language suspending the debt limit for a period of time and allowed the limit to reset itself when the suspension period ended. The amount of the reset is equivalent to the amount of debt Treasury had to issue during the suspension period to keep the government operating. Congress suspended the debt limit twice in 2013 and again in 2014, 2015, 2017, 2018 and 2019.
What happens when the debt limit comes back to life in August 2021?
The Treausry will not be able to pay its bills by selling notes, bonds or other securities. It will be able to use available cash, but that will quickly dwindle. To create some room under the new debt limit, the Treasury Secretary can declare a “debt issuance suspension period,“ which allows Treasury to take “extraordinary measures.” These include:
- Suspending sales of State and Local Government Series Treasury securities;
- Redeeming existing, and suspending new, investments of the Civil Service Retirement and Disability Fund and the Postal Service Retiree Health Benefits Fund;
- Suspending reinvestment of the Government Securities Investment Fund; and
- Suspending reinvestment of the Exchange Stabilization Fund.
It is unclear how much time these extraordinary measures will buy, but it will probably be no more than a few months, forcing an inevitable crisis. As described by GAO, “Failure to increase or suspend the debt limit in a timely manner could undermine the perceived safety of Department of the Treasury (Treasury) securities, resulting in serious negative consequences for the Treasury market and increased borrowing costs. The full faith and credit of the United States must be preserved.”
A default would have devastating effects on U.S. and global economies and the public. It is generally recognized that a default would prevent the government from honoring all of its obligations to pay for such things as program benefits; contractual services and supplies; employees’ salaries, wages, and retirement benefits; and principal on maturing securities. One cannot overstate the importance of preserving investors’ confidence that debt backed by the full faith and credit of the U.S. government will be honored. The perceived safety of Treasury securities supports broadbased demand for U.S. government debt. Many investors accept low yields on Treasury securities because they are considered one of the safest assets in the world. This enables Treasury to keep borrowing costs low. - GAO, March 2020
What can be done?
As part of a comprehensive fiscal sustainability plan, the president and Congress should consider debt limit reform.
In a 2011 report, 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.
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.
Another possibility would be to replace the current dollar cap entirely and adopt a new system that would set a targeted ratio of debt-to-GDP and require actions or automatic consequences if the debt exceeded that level.
In a 2015 report, the GAO examined three alternatives to the current system:
- Link action on the Debt Limit to the Budget Resolution
- Provide the Administration with the authority to increase the Debt Limit, subject to a Congressional Motion of Disapproval
- Delegating broad authority to the Administration to borrow as necessary to fund enacted laws
All of these ideas should be considered. However, there should be no mistake about debt limit increases; we have to pay our bills.