treasury
Aug 12, 2021

The Debt Ceiling: The Gamesmanship Begins

The clock is ticking for Congress to reach a deal to raise the federal borrowing limit — the debt ceiling. On July 23, 2021, Secretary of the Treasury Janet Yellen notified Congress that, as of Aug. 1, the outstanding debt of the United States will be at the statutory limit and the Treasury would use extraordinary measures, including suspending the sale of nonmarketable debt, to prolong the period before Congress needs to act.

Under normal circumstances, the Treasury has sufficient financial resources to pay all obligations arising from discretionary and mandatory spending, including interest payments on the debt partly due to its ability to borrow funds. Once the country hits the debt ceiling, the Treasury cannot borrow more unless Congress votes to raise the ceiling. The Congressional Budget Office (CBO) and other third-party analysts predict that the extraordinary measures probably will allow the Treasury to make it to early fall or October or November before congressional action would be needed, either to raise the debt limit or suspend it. The CBO also notes that the government’s obligations are about twice as much as the revenue it expects to collect.

When Senate Democrats released their budget resolution, it did not contain a provision to raise the debt limit. On the same day, Senate Minority Leader Mitch McConnell (R-Ky.) doubled down, saying Republicans would not be a part of raising the debt limit for Democrats to spend. He in essence dared the Democrats to push through an increase in the debt limit using only Democratic votes, just as they plan to do for budget reconciliation. On Aug. 11, Senate Majority Leader Chuck Schumer (D-N.Y.) pointed out that this usually has been a bipartisan issue and that the White House and the Treasury wanted this to be resolved outside of budget reconciliation, so it would be a bipartisan response and because rules related to reconciliation would limit solutions.

What happens to government payments when the country hits the debt limit?

The limit applies to almost all federal debt, including the roughly $22.3 trillion of debt held by the public and the roughly $6.2 trillion the government owes itself as a result of borrowing from government accounts, such as the Social Security and Medicare trust funds. When borrowing hits the debt ceiling, the government is no longer allowed to issue debt and must rely only on the cash on hand.

At that point, incoming receipts will be insufficient to pay millions of daily obligations as they come due. Therefore, the debt limit would cause delays related to payments for government activities, a default on the government’s debt obligations, or both. This includes Social Security payments, Medicare reimbursements, salaries for federal civilian employees and the military, and veterans’ benefits, among others.

From July through September, CBO estimates, federal revenues and outlays will total $786 billion and $1,551 billion, respectively (some of that difference will be covered by drawing down cash balances). Certain large flows of cash into and out of the Treasury follow a regular schedule that directly affects the amount of federal borrowing from the public, the largest component of debt subject to the limit. The following are typical payment dates and amounts for large government expenditures (although actual disbursement date may shift by a day or two if a normal payment date falls on a weekend or federal holiday):

  • Payments to Medicare Advantage and Medicare Part D plans are made on the first day of the month (about $35 billion).
  • Social Security benefits are disbursed on the third day of the month (about $22 billion), with subsequent payments on three Wednesdays each month (about $20 billion each).
  • A large share of the pay for active-duty members of the military and the vast majority of benefit payments for civil service and military retirees, veterans and recipients of Supplemental Security Income are disbursed on the first day of the month (about $25 billion).
  • Interest payments are made around the 15th and the last day of the month (amounts vary).

Deposits into the Treasury (mostly in the form of tax revenues) are relatively steady throughout each month except for a few dates on which tax receipts are particularly large. Corporate income taxes are paid quarterly, with the next payments due in mid-September.

Medicare, Social Security and Debt Ceiling

If Treasury delays investing a federal trust fund’s revenues in government securities, or redeems prematurely a federal trust fund’s holdings of government securities, the result would be a loss of interest to the specific trust fund. This could worsen the financial situation of the affected trust fund(s) and accelerate insolvency dates.

The Social Security and Medicare trust funds were created to account for monies that are dedicated to those programs. The funds accounts maintained by the Department of the Treasury provide a mechanism for tracking all program income and disbursements. Accumulated assets of the funds represent automatic authority to pay program benefits (that is, no annual legislation is needed to spend a portion of trust fund assets on these costs). If the trust funds were exhausted, congressional action would be needed to pay benefits not covered by current program revenues.

While the trust funds are treated separately under budget rules, what is important to understand is the flow of funds between general revenue and the respective trust funds. The Medicare program has two trust funds: the Hospital Insurance (HI) and the Supplementary Medical Insurance (SMI) Trust Funds. The HI trust fund is financed primarily by payroll contributions. Other income includes a small amount of premium revenue from voluntary enrollees, a portion of the federal income taxes beneficiaries pay on Social Security benefits and interest credited on the U.S. Treasury securities held in the HI trust fund. Parts B and D of SMI are financed by transfers from the general fund of the Treasury. Beneficiaries pay 25 percent of the Part B costs in the form of monthly premiums.

When a trust fund invests in U.S. Treasury securities, it has loaned money to the rest of the government. The value of the securities held is recorded in the budget as “debt held by government accounts” and represents debt one part of the government owes to another. The securities constitute a liability for the Treasury because the loan must be repaid when the trust fund needs to redeem securities in order to make benefit payments. As with marketable bonds, these Treasury securities are backed by the full faith and credit of the U.S. government.

A rough analogy would be to think of the general fund as a checking account from which purchases of all sorts can be made. The trust funds represent retirement savings accounts with specific rules for withdrawals. For example, the SMI trust fund receives large transfers from the general fund, the size of which depends upon how much the program spends, as opposed to how much revenue comes into the Treasury. If non-dedicated revenues become insufficient to cover both the mandated transfer to SMI and expenditures on general government programs, the Treasury must borrow to make up the difference. If the debt ceiling prohibits borrowing, the Treasury has insufficient funds to make up the difference.

What will Treasury do if borrowing hits the debt ceiling and Congress does not act?

Some have argued that Treasury can prioritize payments to avoid a default on federal obligations by paying interest on outstanding debt before other obligations. Treasury officials, however, have maintained that there is no formal legal authority to pay obligations. In other words, the law could be interpreted to mean the Treasury has to make payments on obligations as they come due. The Congressional Research Service has pointed to two different interpretations: In August 2012, the Treasury inspector general stated that “Treasury officials determined that there is no fair or sensible way to pick and choose among the many bills that come due every day.” In 1985, however, the Government Accountability Office wrote to then-Chairman Bob Packwood of the Senate Finance Committee that it was aware of no requirement that Treasury must pay outstanding obligations in the order in which they are received.

The overarching fact is that the federal government’s inability to borrow or use other means of financing implies that payment of some or all bills and obligations would be delayed and uncertain.

In 2011, the debt-limit issue actually had some impacts on the government. For one, the U.S. debt rating was lowered. That sent shudders through financial markets. A 2013 report by the Treasury Department said, "Because the debt ceiling impasse contributed to the financial market disruptions, reduced confidence and increased uncertainty, the economic expansion [in 2011] was no doubt weaker than it otherwise would have been."

Secretary Yellen has called on congressional leaders to find a bipartisan solution. "In recent years Congress has addressed the debt limit through regular order, with broad bipartisan support," she wrote. "I respectfully urge Congress to protect the full faith and credit of the United States by acting as soon as possible."

The debt limit looms. Some think that, given the passage of the budget resolution, Republicans might hold the debt ceiling hostage for changes in entitlement spending or caps on overall spending. Yet, more recently, in 2019 under the Trump administration, Republicans and Democrats came together to take the debt ceiling off the table temporarily.

When Congress returns to work after their recess, they will have to address appropriations to keep the government running, the budget reconciliation package and the debt ceiling. To not act on the debt ceiling would create great uncertainty.