Everything You Needed to Know About the Debt Ceiling, Part 2

Yesterday, we updated our Q&A: Everything You Needed To Know About the Debt Ceiling to reflect the newest date for the debt ceiling, which will be reinstated after February 7. The debt ceiling was suspended in mid-October, following a partial government shutdown, and will be reinstated on Friday. This suspension will result in a de facto $600 billion increase, putting the new debt ceiling at approximately $17.3 trillion. After this date, the Treasury will start to use extraordinary measures, in order to allow the United States to continue borrowing and fulfill its obligations. Treasury Secretary Jacob Lew recently estimated that these extraordinary measures will be exhausted by late February, and urged Congress to take measures to raise the debt ceiling before that time.

Our Debt Ceiling Q&A explains the history and mechanics of the debt ceiling, as well as suggesting ways to responsibly address it. Below we summarize several of the questions that the primer answers. Click here to read the full Q&A.

What is the debt ceiling?

The debt ceiling is the legal limit on the total level of federal debt the government can accrue. The limit applies to almost all federal debt (certain types of debt are exempt, but are quite small in value), including the debt held by the public and what the government owes to itself through various accounts such as the Social Security and Medicare trust funds. The debt ceiling applies to both debt held by the public as a result of borrowing necessary to finance deficits, and debt owed to trust funds. As a result,  the debt subject to limit increases both as a result of annual budget deficits financed by borrowing from the public and increases in government trust fund balances invested in Treasury bills. The current debt subject to limit of more than $16.7 trillion is composed of nearly $12 trillion in debt held by the public and slightly more than $4.7 trillion in debt held by government accounts.

What happens if the debt ceiling is breached?

Once the government hits the debt ceiling and exhausts all available extraordinary measures, it is no longer allowed to issue additional debt. At that point, the government must rely on its remaining cash on hand and incoming receipts to pay all obligations. However, when the federal government is in a period of running annual deficits – as is the case today – incoming revenues to the federal government are insufficient to cover all of the government’s obligations, be it salaries for federal civilian employees and the military, utility bills, veterans’ benefits, or Social Security payments, to name a few. Between October 18th and November 15th, for example, the Bipartisan Policy Center estimates that approximately 32 percent of the government’s obligations would have to go unpaid, if relying only on incoming receipts to pay bills. Instead of or in addition to failing to meet these obligations, the government could also potentially default on regular interest payments on the debt.  A default, or even the perceived threat of a default, could have serious negative economic implications.

Can this be avoided without congressional action?

The Department of Treasury can use a variety of accounting gimmicks to postpone hitting the threshold. For example, it can prematurely redeem treasury bonds held in federal employee retirement savings plans, halt contributions to government pension funds, or accumulate certain special types of debt which are not subject to the limit. While these actions are within the Treasury's authority, they do not make for very good policy, and can have negative economic, financial, and political consequences.

What should policymakers do?

Failing to raise the debt ceiling would be disastrous, and would surely, and rapidly, result in severely negative consequences that experts are not capable of fully knowing in advance. Even threatening a default or taking the country to the brink of default could have serious negative repercussions. Given these facts, Congress and the President must raise the debt ceiling – and they should do so as soon as possible. Yet they should also pursue a deficit reduction plan which would ideally replace the sequester, reform the tax code to make it simpler and raise more revenue, slow the growth of entitlement programs, and put the debt on a clear downward path relative to the economy.

We hope that this Q&A will be a useful primer on the debt ceiling. Although the need to raise the debt ceiling can serve as a useful moment for taking stock of our fiscal state, lawmakers should enact a comprehensive deficit reduction plan without jeopardizing the full faith and credit of the U.S. government.