The debt limit is a legal cap on the amount of borrowing the U.S. Treasury can undertake. When the federal government spends more than it collects in revenue, it finances the deficit by issuing U.S. Treasury securities. Historically, before 1917, each Treasury loan required Congress’s authorization. However, during World War I, Congress altered the law to allow the Treasury to sell war bonds (Liberty Bonds) without exceeding a specific limit, known as the debt limit.
Over the past three decades, the debt limit has become a contentious issue, with some legislators using it to curtail federal spending. For example, in 2011, a stalemate was resolved with the Budget Control Act, which raised the debt ceiling and imposed future spending limits. Congress can either increase the debt ceiling by a fixed amount or suspend it for a specified period. When the debt ceiling is raised, borrowing can continue until the new limit is reached. For instance, in December 2021, the debt ceiling was increased from $28.9 trillion to $31.4 trillion. Conversely, when a suspension period ends, the debt limit is reinstated at a level that accommodates the borrowing that occurred during the suspension. For example, in August 2019, the debt ceiling was suspended for 24 months, during which an additional $6.4 trillion was borrowed. When the suspension ended in August 2021, the debt limit was reinstated at $28.4 trillion.
Once the debt limit is reached or a suspension period ends, the Treasury can employ “extraordinary measures” to keep the debt from rising until Congress acts. These measures typically involve suspending the reinvestment of certain government funds to create space for public debt. For example, in August 2021, suspending the reinvestment of the G Fund (a retirement fund for federal employees) freed up $270 billion in debt, allowing the Treasury to borrow $262 billion. These measures provide temporary relief but do not prevent the government from eventually reaching the debt ceiling. Without congressional action, the Treasury’s ability to pay its bills will be constrained by daily revenue.
Does Raising the Debt Ceiling Allow the Government to Spend More Money?
Raising the debt ceiling does not authorize additional government spending beyond what Congress has already approved. Instead, it enables the government to meet its existing obligations to citizens, vendors, and bondholders. These obligations include Social Security benefits, military paychecks, and interest payments on the national debt.
What Happens When Treasury Hits the Debt Ceiling?
When the Treasury reaches the debt ceiling, it uses a series of cash-saving tools known as “extraordinary measures.” These measures temporarily reduce intragovernmental debt (Treasury securities held by other government agencies) to create space for public debt. One method is suspending the daily reinvestment of certain government funds. For example, preventing the reinvestment of the G Fund lowers Treasury’s total debt, allowing it to issue debt to the public once again. While these measures buy time, they are insufficient to prevent the government from hitting the debt ceiling. Without raising the debt limit, the Treasury will eventually run out of cash to meet its obligations, depending on the flow of revenues and spending.
What Does it Mean for the Treasury to Run Out of Cash?
Every day, the Treasury collects revenues from taxes and pays its bills, including Social Security benefits, utilities in federal buildings, and interest on the debt. When expenses exceed revenues, and the Treasury cannot borrow more due to the debt ceiling, it can only cover expenses to the extent that there is cash coming in. This means there will be enough money to pay some-but not all-of the government’s bills and obligations.
Why is Raising the Debt Ceiling so Controversial?
The debt limit has become a flashpoint for debates about the size of the federal budget. Politicians who want to reduce deficits or restrain government spending have used the debt limit to negotiate spending caps or budget restrictions. For instance, in 2011, the debt limit was raised in exchange for future spending limits. Some view this “fiscal brinksmanship” as irresponsible and argue that raising the limit should be routine. Since 1960, Congress has lifted, temporarily extended, or revised the debt limit 78 times. Others, including former Treasury secretaries, advocate for abolishing the limit, arguing it imposes unnecessary costs on taxpayers and puts the government’s solvency at risk. Proponents of the debt limit argue it imposes fiscal discipline in Washington.
What if Congress Doesn’t Act?
If Congress fails to act, the Treasury will be unable to meet all its obligations. This could have severe political ramifications, especially if benefits like Social Security or military paychecks are delayed. Moreover, failing to make interest or principal payments on time could damage the market’s view of U.S. government debt, potentially increasing interest rates on Treasury bonds. During the 2021 round of extraordinary measures, Treasury Secretary Janet Yellen warned that running out of cash would put various beneficiaries and military families at risk. Prioritizing interest payments over other bills might discourage investors from fleeing Treasuries, but a debt breach could still make rolling over matured debt difficult. Rollover occurs when short-term securities mature, and the proceeds are reinvested or other investors buy Treasury securities. If investors react negatively to a debt breach, the Treasury could face difficulties finding buyers for those securities, potentially leading to a rapid escalation of the debt situation.
As Long as Congress Acts, Even at the Last Minute, Is Everything OK?
No. Evidence from past debt ceiling impasses shows that investors may dump Treasury securities with maturity dates around the projected limit date, leading to spikes in rates and reduced liquidity in the Treasury securities market. This can ripple through financial markets, making federal debt more expensive. For example, a Government Accountability Office study estimated that the 2011 debt limit showdown raised Treasury borrowing costs for debt that matured in 2011 by $1.3 billion. These effects underscore the importance of timely congressional action to avoid financial disruptions.
