June 27, 2019

Debt Limit 101


KEY TAKEAWAYS

  • The current statutory debt limit – $21,987,705,611,407 – was established on March 2 when the previous debt limit suspension period expired and the ceiling was reset to reflect the current amount outstanding.
  • The Treasury Department is using extraordinary measures to temporarily avoid breaching the limit, but eventually Congress must act.
  • History shows that the financial and economic turmoil caused by a debt limit impasse lingers even after lawmakers have raised the limit.
  • Treasury expects to exhaust all extraordinary measures by late summer.

The Treasury Department is responsible for managing the finances of the federal government. It collects revenues, pays the bills, and borrows money when there isn’t sufficient revenue to cover expenses.

The Constitution gives Congress sole authority to raise taxes and appropriate new spending; by extension this includes the power to regulate the amount of federal debt Treasury can issue. Before 1939, Congress generally managed this task by capping the face value of individual debt sales, but when that proved unwieldy an overall limit was adopted.

WHAT IS THE DEBT LIMIT?

The current statutory debt limit – $21,987,705,611,407 – was established on March 2 when the previous debt limit suspension period expired, and the ceiling was reset to reflect the current amount outstanding. As of June 25, total debt subject to limit was within about $25 million of the limit.

Like a car’s rearview mirror, the statutory debt limit is a backward-looking indicator. The need to increase the debt limit reflects the cumulative budgetary effects of spending and revenue decisions made in the past. Today, increases in the debt limit are largely driven by promises that were made decades ago in programs like Social Security and Medicare. As the costs of these programs are permitted to grow without reform, so will the need to raise or suspend the statutory debt limit.

Ninety-nine percent of all federal debt is subject to the statutory limit. Exceptions include debt issued by the Federal Financing Bank, debt issued prior to 1917, and old currency notes. Debt subject to limit is categorized two ways:

  • Debt held by the public is comprised of bills, bonds, and notes that Treasury issues to the public to raise operating cash. These securities pay interest, can be traded in secondary markets, and are held by non-federal entities such as individual or institutional investors; state and local governments; foreign central banks; and the Federal Reserve System. Approximately $16 trillion – or 73% – of total federal debt is held by the public.

  • Debt held by government accounts, also known as intragovernmental debt, is held by trust funds like Social Security, Medicare, military retirement, and civil service retirement and disability. For example, surplus payroll taxes collected by the Social Security Administration are used to purchase special obligation bonds that are held by the Social Security trust funds. This type of debt is not tradeable but does earn interest. Approximately $5.9 trillion – or 27% – of total federal debt is intragovernmental debt.

Increases in either category push the government’s indebtedness closer to the statutory debt limit.

the way we raise the debt limit has changed

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 78 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 post-recession politics of trillion-dollar deficits and commensurate increases in the debt limit became politically unpopular, however, a more nuanced solution emerged.

Statutory Debt Limit 2009-2019

Debt Limit

Source: Bipartisan Policy Center

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, and 2018.

the costs of failing to raise the limit

The United States has never defaulted on its debt, so no one knows precisely what would happen. An October 2013 Treasury report on the 2011 debt crisis concluded, “default would be unprecedented and has the potential to be catastrophic: credit markets could freeze, the value of the dollar could plummet, U.S. interest rates could skyrocket, the negative spillovers could reverberate around the world, and there might be a financial crisis and recession that could echo the events of 2008 or worse.” Specifically, in 2011:

  • Consumer confidence fell 22% and business confidence fell 3%.

  • The S&P 500 index fell 17%.

  • Stock market declines caused household wealth to fall $2.4 trillion and retirement assets to lose $800 billion in value.

  • The average 30-year conventional fixed-rate mortgage rose 70 basis points and corporate risk spreads on BBB-rated corporate debt jumped 56 basis points.

The Treasury report noted that the financial market stress that began in August 2011 persisted into 2012 even though Congress raised the debt limit.

A 2015 Government Accountability Office report revealed that during the 2013 debt limit impasse investors took unprecedented actions to avoid certain Treasury securities. As a result, interest rates rose and liquidity declined in the secondary markets for those assets. Since many private debt instruments are pegged to Treasury interest rates, ripple effects extended into other markets. GAO found that Treasury incurred $38 million to $70 million in higher borrowing costs in the final weeks leading up to the deadline when extraordinary measures would be exhausted.

TREASURY can avoid default, temporarily

The Treasury Department has always been able to pay its obligations – principal and interest – on time, which is one reason the United States enjoys a AAA bond rating with two of the three rating agencies and can issue debt at very low interest rates. There have been occasions, however, where Treasury has resorted to “extraordinary measures” to avoid breaching the limit while waiting for Congress to act. Treasury has been actively managing the federal government’s finances in this manner since the previous debt limit suspension period expired on March 1 and the current debt limit was reset.

The treasury secretary can conserve or create “headroom” by temporarily suspending a number of fiduciary responsibilities to invest in Treasury securities. Some of these actions are more effective than others in creating a buffer against a breach, but none can be carried out indefinitely; eventually, Congress must act.

Extraordinary measures the treasury secretary has taken this year:

  • On February 21, Secretary Mnuchin advised Congress that he would suspend the sale of State and Local Government Series securities. These help state and local governments comply with federal tax laws when they have cash proceeds to invest after their sale of tax-exempt bonds. SLGS securities count against the federal debt limit.

  • On March 4, and again on May 23, Secretary Mnuchin advised Congress that he would redeem a portion of existing investments, and suspend new investments, of the Civil Service Retirement and Disability Fund and the Postal Service Retiree Health Benefits Fund. These funds facilitate the payment of defined benefits to government retirees. Balances not used to pay immediate benefits are invested in Treasury securities, which count against the debt limit. 

  • On March 5, Secretary Mnuchin advised Congress that he would suspend reinvestment of the Government Securities Investment Fund, known as the G Fund. This is a defined-contribution money market retirement fund – one of several investment options for federal employees who participate in the Thrift Savings Plan. The G fund is invested in special-issue Treasury securities, which count against the debt limit. Ordinarily, the entire balance matures daily and is reinvested.

Though Secretary Mnuchin has not taken these steps yet, he could:

  • Suspend reinvestment of balances in the Exchange Stabilization Fund. In general, the ESF is used to buy and sell foreign currencies. A portion of the ESF is held in U.S. dollars and the dollar balance is invested in special-issue Treasury securities that count against the debt limit. The dollar-balance portion of the portfolio matures daily and is typically reinvested.

  • Exchange investments held by the Federal Financing Bank. The Federal Financing Bank, a government corporation under the supervision of the treasury secretary, can issue up to $15 billion of its own debt. FFB debt does not count against the statutory debt limit, so any unused debt capacity can be used to purchase Treasury securities held by the Civil Service Retirement and Disability Fund, freeing up additional public-debt capacity.

Current law requires that any people or accounts affected by these actions be made whole, with interest, when the new debt limit is enacted. Interest lost by non-reinvestment of the ESF, however, is not restored.

Debt Capacity Made Available by Extraordinary Measures

Debt Limit

Source: Bipartisan Policy Center and Treasury Department

What is the X Date?

Once all extraordinary measures have been exhausted, Treasury will have only incoming daily revenues and cash on hand to meet expenses. If those resources are insufficient, the federal government will begin to default on its obligations. The first day this happens is called the X Date.

No one knows precisely when the X Date will arrive; several factors make the prediction uncertain. First, revenues are “chunky” – the government receives most of its revenues in January, April, June, and September, when annual and quarterly tax payments are due. Predicting those receipts with accuracy is difficult. Second, policy changes enacted by Congress, such as emergency spending to aid in natural disaster recovery, can have an immediate and significant effect on outlays. General economic conditions also can affect spending and revenue collections. When the U.S. economy slows, the first signs are often reduced receipts from paycheck withholding and a rise in counter-cyclical spending programs like unemployment and food stamps.

With these risks in mind, Treasury, CBO, and the Bipartisan Policy Center point to a current X Date between late summer and early November.

Issue Tag: Taxes