What is the Debt Limit and Why It Matters

What is the Debt Limit and Why It Matters

Earlier this month, Congress approved a bill to raise the U.S. debt limit to $480 billion, averting a potential default...

Earlier this month, Congress approved a bill to raise the U.S. debt limit to $480 billion, averting a potential default. However, lawmakers only bought themselves additional time and will have to address the debt limit before Congress adjourns in December. If Congress fails to reach a deal and can’t pay its obligation, it could trigger a recession, according to U.S. Treasury Secretary Janet Yellen. Accordingly, there is hope that the two parties can reach a long-term deal.

History of the Debt Limit

The deeply-partisan debate over raising the debt ceiling made headlines and drew attention to an important aspect of the federal budget process. In basic terms, the debt limit is the total amount of money that the U.S. government is authorized to borrow to meet its existing obligations. Debt subject to limit accounts for more than 99% of total federal debt and includes debt held by the public (which is used to finance budget deficits) and debt issued to federal government accounts (which is used to meet federal obligations), according to the Congressional Research Service.

Article I Section 8 of the U.S. Constitution gives Congress exclusive authority to borrow money on the credit of the United States. Prior to 1917, Congress directly authorized each individual debt issued. In enacting the Second Liberty Bond Act of 1917, Congress established the first “debt ceiling” in setting an aggregate limit on the total amount of new bonds that could be issued. Through the 1920s and 1930s, Congress amended the restrictions to give the U.S. Treasury greater flexibility in managing the country’s debt and to facilitate the modernization of the federal budget process. In 1939, Congress established the first overall aggregated debt limit, capping it at $45 million.

Raising the Debt Ceiling

Raising the debt limit allows the federal government to pay for federal spending that has already been authorized by Congress. Accordingly, it does not reflect either party’s future spending proposals.

When debt levels approach the debt ceiling, Congress has several options, including: (1)leaving the debt limit in place; (2) increasing the debt limit to allow for further federal borrowing; (3) maintaining the current debt limit and require the implementation of “extraordinary measures”; or (4) temporarily suspend or abolish the debt limit. The first step is generally for the Treasury Department to use several accounting tools, referred to as extraordinary measures, to avoid defaulting on the government’s obligations. However, these measures can only buy so much time. Once they are exhausted, the Treasury can’t issue any new debt and may ultimately deplete its cash-on-hand. In light of fiscal budget deficits, the country’s incoming revenue generally isn’t enough to satisfy its ongoing obligations as they come due.

Most experts agree that a default, even if temporary, would be enough to cause economic upheaval. According to the Committee for a Responsible Federal Budget, “an actual default would roil global financial markets and create chaos, since both domestic and international markets depend on the relative economic and political stability of U.S. debt instruments and the U.S. economy.”

Congress has enacted nearly 100 separate debt limit modifications between the end of World War II and today. Since the late 1950s, the federal government increased its borrowing each year, with the exception of FY1969 and the period from FY1998-FY2001. Lawmakers have suspended the debt limit seven times since 2013, with the most recent suspension ending on July 31, 2021. While it has certainly come close, the federal government has never defaulted. Nonetheless, the recent partisan stalemate over raising the debt ceiling has resulted in calls to reform how the debt limit is managed. Under legislation proposed by House Budget Chair John Yarmuth (D-KY) and Rep. Brendan Boyle (D-PA) the Treasury secretary, rather than Congress, would be charged with raising the cap on the federal government’s borrowing authority. Of course, given the current political climate, it is unclear whether Congress would enact such legislation.

If you have questions, please contact us

If you have any questions or if you would like to discuss the matter further, please contact me, Teddy Eynon, or the Scarinci Hollenbeck attorney with whom you work, at 201-896-4100.