U.S. Debt Ceiling

What is the U.S. Debt Ceiling?

The debt ceiling is the maximum amount of money that the U.S. federal government is legally allowed to borrow to meet its existing financial obligations.

These obligations include:

• Funding government operations,
• Paying federal salaries,
• Servicing debt held by the public and foreign governments.
• Providing citizens with benefits such as Social Security, Medicare, and veterans’ benefits.

The debt ceiling is set by Congress and has been raised many times over the years to account for growing budget deficits and the accumulation of debt.

If the ceiling is reached, the Treasury Department cannot issue any additional securities – i.e., bonds – to raise cash and can only spend incoming tax revenues.

Failing to raise the debt limit in time for the government to continue meeting all its obligations would force the Treasury to default on some commitments. It could provoke an economic catastrophe as it would be the first time that the country would default on its debt in its history.

History of the Debt Ceiling

The debt ceiling was instituted with the Second Liberty Bond Act of 1917, which enabled borrowing to finance the United States’ entry into World War I. Prior to this, Congress had to authorize each new issuance of debt separately.

Since 1960, Congress has acted 78 times to expand, temporarily extend, or revise the debt ceiling. This has occurred under both Democratic and Republican presidents and congresses.

Reaching the Debt Limit

When federal debt levels reach the statutory limit, the Treasury cannot borrow any more money to bridge the gap between spending and revenues. It must rely only on incoming taxes and extraordinary measures to fund obligations.

These extraordinary measures include;

• Suspending investments in federal employee retirement funds;
• Exchanging government funds.

Once these options are exhausted, no alternatives remain to avoid defaulting on the country’s payments.

Between July 2021, when the ceiling was reinstated, and January 2023, when it was reached again, the total debt subject to limit increased by about $2 trillion to the existing $31.4 trillion limit.

The Bipartisan Policy Center estimated that extraordinary measures would last until mid-2023.

Consequences of Default

If Congress fails to raise or suspend the debt ceiling in time, the federal government will no longer be able to meet all of its legal financial obligations.

The resulting consequences could include, but are not limited to:

• Missed payments on Treasury bonds, notes, and bills, which constitute a formal default in the eyes of the credit market;
• Unpaid benefits for Social Security, Medicare, Medicaid, veterans, and more;
• Halting of student loan payments, tax refunds, military paychecks, and other obligations;
• The downgrade of U.S. credit rating and higher borrowing costs;
• Trillions of dollars in losses from the collapse of stock and bond market valuations;
• Widespread business and personal bankruptcies due to higher financing costs and other collateral damages;
• Massive job losses and a possible increase in homelessness due to a wave of foreclosures and forced tenant vacancies;
• A deep and long-lasting recession that could reach a global scale due to the importance of the US economy to global trade.

Even coming close to defaulting could destabilize the financial markets and undermine the public’s confidence in the perceived creditworthiness of Treasury securities.

Rating agencies may downgrade U.S. debt if brinkmanship continues.

Debt Ceiling Showdowns

In recent years, the routine debt ceiling increase has turned into a political battle.

Some major crises include:

In these episodes, the ceiling was ultimately raised or suspended before a catastrophic default occurred.

However, the associated uncertainty that prevails during these procedures and standoffs usually weighs on the financial markets.

Debt Limit Solutions

To resolve debt ceiling impasses, some proposals that both lawmakers and administrations have pushed forward include:

• Abolishing the Limit: Elected officials would be in charge of approving debt limits and spending plans without Congress oversight.
• Presidential Executive Actions: Minting a trillion-dollar coin to pay off the country’s debt by crediting the Treasury with that amount and then recouping the funds once the debt limit is ultimately raised.
• Legal Recourses: Invoking the 14th Amendment is also a possibility that has been considered by the administration to bypass the debt ceiling. This idea, however, has not gained traction within the current Biden administration.
• Congressional Rules Changes: Requiring supermajorities to block increases. This would make it more difficult for lawmakers to band together as they would have to convince Congressmen from both parties to join forces.
• Automatic Increases: Removing periodic votes to raise the ceiling and define a system that automatically lifts the ceiling as needed to remove the need to sustain subjective discussions over the topic.

Despite an often heated debate over these options, the only certain way to avert potential default is for Congress and the President to agree on legislation to raise or suspend the limit in a timely manner.

Even coming close to the brink can jeopardize market stability and harm the economy. The debt ceiling only enables borrowing for spending that has already been approved by Congress and the President, making periodic increases necessary to encourage and maintain some degree of fiscal responsibility.