The Truth About the Debt Ceiling

Separating economic fact from economic myth

Editor’s Note: Reason columnist Veronique de Rugy appears weekly on Bloomberg TV to separate economic fact from economic myth.

The statutory debt limit, or debt ceiling, was designed to control congressional spending by limiting the amount of debt the federal government could accumulate. Clearly, it has not fulfilled its legislative purpose. In fact, the government has lost its ability to monitor its own spending. Having to raise the debt ceiling yet again is a sign that Congress has failed to do what is necessary to get the nation’s finances in order. Here are three myths about the debt ceiling, each one rebutted by a fact.

Myth 1: Failure to increase the debt ceiling is insanity. Unless we increase the debt ceiling, the U.S. government will default on its debt.

Fact 1: The federal government has other options. If the debt ceiling is not increased, the Treasury Department can make interest and debt payment its first priority to avoid a default. Then it can essentially put the government on a stringent pay-as-you-go basis.

The Obama administration warns of an economic armageddon if Congress doesn’t raise the debt ceiling. It is called “insanity” not to take the simple step of allowing the government to borrow more money. Treasury Secretary Timothy Geithner has warned that if we don’t increase the debt ceiling the U.S. would default, resulting in a bond market crash with disastrous impacts felt at home and abroad.

Really?

Technically, if the debt nears its statutory limit, the Treasury Department cannot issue new debt to manage short-term cash flows or manage the annual deficit—the government may therefore be unable to pay its bills. But in the real world things are different.

First, if the debt ceiling is not increased it doesn’t mean the federal government will have to repay the entire debt at once. The government just won’t be able to increase its borrowing. Americans understand the difference between not being able to borrow more money and defaulting on one’s mortgage.

Also, while Congress has never before refused to raise the debt ceiling, it has frequently taken its time about doing so (see the chart below). In 1985, for example, Congress waited nearly three months after the debt limit was reached before it authorized a permanent increase. In 1995, four and a half months passed between the time that the government hit its statutory limit and the time Congress acted. And in 2002, Congress delayed raising the debt ceiling for three months. It took three months to raise the debt limit back in 1985 as well. In none of those cases did the world end.

More importantly, the Treasury Department has other options. For instance, if the debt ceiling is not increased, the Treasury can prioritize interest and debt payment to avoid a default. The chart below shows what part of the budget Treasury needs to cover with tax revenue to avoid a default.

If Congress refuses to raise the debt ceiling, the federal government will still have more than enough money to fully service the debt. This year, for instance, about 6.1 percent of all projected federal expenditures will go to interest on the debt, and tax revenue is projected to cover about 60.1 percent of all government expenditures. With roughly 10 times more income than needed to honor its debt obligations, why would the government ever default?

Let’s sum it up: As long as the government continues to pay interest on the debt, then it technically is not in default. With tax revenues expected to be $2.2 trillion, interest payments amount to roughly $300 billion—this would still leave $1.9 trillion in revenues to pay for the government's most important priorities. For instance, lawmakers could decide to honor the promises made to people benefiting from entitlement spending, such as Social Security, Medicare, and Medicaid. In that case, even after paying for all of the entitlement spending, the Treasury would still have $300 billion left.

Would that involve cuts in government spending? Absolutely. But it could, and should, be done.

Would it make the bond market nervous? Yes, it would. Not raising the debt ceiling would probably introduce additional uncertainty. However, market participants (especially foreign creditors who now own a majority of our debt held by the public) may have already changed their expectations due to the increased attention to this issue and because of the alarmist language being used by the Treasury and White House.

With some signs of life—such as increases in consumer spending—we could expect declines in demand for Treasury and fixed-income assets. However, the Federal Reserve is still actively purchasing notes, which will likely increase demand. Ultimately, it makes predictions on the effect of interest rates very tricky.

One thing is certain: not increasing the debt ceiling will make us travel to a new equilibrium, which almost always means a certain level of disruption in the short term. But shouldn't such change be the easiest way to mitigate short-term concerns while moving to a more sustainable long-term equilibrium?

Those who are worried about default should realize that our ability to remain solvent depends on our continued commitment and ability to pay the interest on our debt, not on our willingness to raise the debt ceiling. As long as we continue to run deficits, our ability to borrow money cheaply, with low interest rates, is the key to avoiding default. 

The chart below shows the budgetary impact after a 1 percent increase in the interest rate.

This could change if investors become worried about their chances of getting paid back. In that case, they might find some safer or more profitable place to invest their capital than the United States government. Also, they may demand an increase in the interest rate for the money they lend. Either of these changes could result if the U.S. government’s reputation as a conscientious debtor is called into question by a continued increase in the demand for funds.

The bottom line is that the government must make serious changes to the way it spends and borrows money, it must stop paying the interest on the debt by borrowing additional money, and it must stop making benefit promises it will never be able to deliver.

Both Moody’s and Standard & Poor’s have warned that our credit rating will be reduced unless we get a handle on our national debt. We’ve heard a lot recently about the European debt crisis, but, as one senior Chinese banking official recently noted, in some ways the U.S. financial position is more perilous than Europe’s. “We should be clear in our minds that the fiscal situation in the United States is much worse than in Europe,” he recently told reporters. “In one or two years, when the European debt situation stabilizes, [the] attention of financial markets will definitely shift to the United States. At that time, U.S. Treasury bonds and the dollar will experience considerable declines.”

Myth 2: These are extraordinary times. We need to increase the debt ceiling now and will cut spending later.

Fact 2: In the last 10 years, Congress has raised the debt ceiling 10 times, sometimes twice in the same year. Congress has raised the debt ceiling 98 times since 1940. The government has lost its ability to monitor its spending. Having to raise the debt ceiling again is a sign that Congress has failed to do what is necessary to get the nation’s finances in order.

The chart above shows the increase in the debt ceiling over the last 70 years. When the statutory debt limit was instituted in 1939, its explicit goal was to limit congressional spending. That purpose is supposedly still the same today. And this limit did work for a while. The chart below shows increases in the federal debt and the statutory debt limit since 1940. As you can see, from 1940 to the beginning of the 1980s, the debt and its limit grew slowly.

The years in which the limit was raised a single time are noted by squares; years in which the limit was raised twice are noted by triangles. The statutory debt limit legally caps, at an amount legislated by Congress, the amount of debt that the United States Treasury may issue. This limit is currently fixed at $14.3 trillion, and our rapidly accumulating debt burden is approaching the cap—as of last week, the outstanding debt subject to the limit was $14 trillion. As federal debt nears this limit, there will be real consequences for the operation of the federal government. Once the debt limit is reached, the Treasury will be unable to issue new debt to manage annual deficits or short-term cash flow issues. In other words, the government may not be able to pay its bills.

Myth 3: Democrats are the big spenders and are the party of debt. We know this because they now want to increase the debt ceiling while Republicans oppose the increase.

Fact 3: Historically, the party in power always wants to increase spending. As a result, lawmakers in power—regardless of party affiliation—overwhelmingly vote to increase the debt limit.

The charts below come from the blog of Urban Institute economist Donald Marron. They show which party voted for the debt ceiling in the Senate and in the House over the last 10 years, revealing that overspending is a bipartisan disease.

Consider, for example, Senate votes on stand-alone debt limit measures over the past decade.

As Marron explains: “When Republicans held both the Senate and the White House (2003, 2004, 2006), they provided virtually all the yea votes, while almost all Democrats voted no. When the Democrats were in power (2009, 2010), the roles reversed: the Democrats provided all but one of the yea votes, while Republicans voted no. Only when government was divided—with a Democratic Senate and a Republican president (2002, 2007)—has the vote to lift the debt limit been bipartisan.”

And as the chart below shows, the same voting pattern occurred in the House.

In conclusion, the data presented above reveals that the debt limit, far from providing fiscal discipline, has in fact served only as a symbolic cap that Congress, regardless of the party in power, will simply push higher and higher as spending increases dictate.

Contributing Editor Veronique de Rugy is a senior research fellow at the Mercatus Center at George Mason University.

Editor's Note: We invite comments and request that they be civil and on-topic. We do not moderate or assume any responsibility for comments, which are owned by the readers who post them. Comments do not represent the views of Reason.com or Reason Foundation. We reserve the right to delete any comment for any reason at any time. Report abuses.

  • Tim||

    DeRugby's views are clearly "outliers"

  • Suki||

    Goodmorning Reason!

  • ||

    Yeah but the song told us to "raise the roof"

  • ||

    I'll be in my bunk.

  • ||

    FIREFLY REFERENCE
    +100

  • ||

    OH MY GOD

  • LibertyMark||

    Holy shit! The best evar!

  • Anonypussy||

    Hate to see the worst.

    F-

  • LibertyMark||

    I feel like my mind has been scalded by acid.

  • Tim||

    MY EYES! MY EYES! MY VISUAL CORTEX!

  • ||

    Goddamn! Nutted in my draws!

  • Warty||

    I may masturbate very soon.

  • ||

    I was getting excited, thought Nancy was going to start consuming John at first taste of the tears awaking twisted appetites long dormant. Chapter 2 please...

  • Wind Rider||

    And Tipper wept. (mostly because Al regularly denied her the release of his chakra - first, or even second)

  • JohnD||

    Yuck! That's enough to put me off sex for the indefinate future.....

  • Mo||

    Isn't the debt ceiling just grandstanding fiction. The SecTreas can get around it for quite a while and have the budget be effected. The important thing is the budget. The Republicans are focusing on the debt ceiling because they aren't doing shit about the budget. Balance the budget and the debt ceiling becomes irrelevant.

  • ||

    Too rational!

    The GOP announced $32 billion in potential cuts today on their make-believe budget - meaning they suck just as much as when Bush/DeLay were in power (well no one could be that bad - but close).

    This is a good article and as Vde Rugy points out there are $225 billion in interest payments due.

    The only reason to vote GOP is if you are some type of weird Aborto-Freak type (or war loving newcon) and even there they habitually disappoint.

  • ||

    The part of shrike's brain that knows the Dems are just as bad as the GOP has been dormant for quite awhile.

  • JohnD||

    Shrike still thinks Denial is a river in Eqypt. What a tool.

  • Jerry||

    This is from 1953: Ike Wins Debt Fight In House

    Passage followed warnings by Republican leaders that failure to raise the lid would prevent the Government from borrowing enough money to pay its bills and might "create panic." Democrats protested bitterly that the 11th hour request, coming as Congress was rushing toward adjournment, was not necessary. Some of them demanded drastic action now to trim Government spending and halt red-ink financing.
  • ||

    Thanks for pointing out that anyone who says failing to raise the debt ceiling will be a default.

    One thing I would point out is that relatively tiny slice of the pie for debt service reflects historically low (and manipulated) interest rates. When those rates break higher (and they will), that slice is going to get a lot bigger, very quickly.

    Its a complicated equation that I don't have the data to run, but I would guess that we will see that number at least double, and I wouldn't be surprised to see it quadruple, five years from now, as more debt gets piled on (at higher rates) and current debt rolls over (at higher rates).

  • nekoxgirl||

    So what happened in the 1980's? Does the growth in debt have anything to do with the stagflation in the 1970's? In other words, instead of abandoning Keynes did the government just start faking it with debt?

  • Invisible Finger||

    Isn't Keynes' solution to go INTO debt? Not sure how we're "faking" Keynesianism here.

  • ||

    The girl accurately pointed out the brain-dying Reagan was a Keynesian on steroids - leading Bush 41 to call his policy "voodoo".

    Reagan was truly a fucking idiot who ran from the 241 dead US Marines but he did shimmy his way into a solid negotiating position with the USSR.

    I am, as always, fair.

  • nekoxgirl||

    I mean faking that Keynesian could still work. The real money wasn't there to continue stimulating demand so the government has gone into increasing amounts of debt to continue the stimulus.

  • Some Guy||

    Isn't Keynes' solution to go INTO debt? Not sure how we're "faking" Keynesianism here.

    Actual Keynesianism has never been tried, much like the free market has never been tried. Keynes advocated running a surplus in the good times to pay for the the debt in the bad times. So if it were ever actually practiced that way, it wouldn't be too bad at all. The deficit we were running at the height of the bubble would be the type of thing that should only be done in a Great Depression type scenario. And of course, you should be spending the money on things that are actually useful like roads and bridges to places other than nowhere.

  • Gilbert Martin||

    "For instance, lawmakers could decide to honor the promises made to people benefiting from entitlement spending, such as Social Security, Medicare, and Medicaid"

    And even if they couldn't there's no reason that those expenditures couldn't be cut first before any debt defaults.

    There's nothing about those obligations that makes them any more "sacred" than paying debt service payments.

    Cash is fungible and cuts can come from anywhere.

    That's what bugged me about Geitner's phony balony claim about having to default on the debt. It is so transparently false that he must think most people in the country are complete economic morons to fall for it.

  • ||

    he must think most people in the country are complete economic morons to fall for it.

    A pretty safe bet so far, no?

  • ||

    "In that case, even after paying for all of the entitlement spending, the Treasury would still have $300 billion left."

    Right...all we have to do is "trim" our non-entitlement spending from roughly $1.9 trillion to $300 billion. Simple as that.

    It's not every day that I sharply disagree with the conclusions of a Reason article, but this one is a real doozy. The notion that we can suddenly chop non-entitlement federal spending by more than 80% is insane. Just because it's easy to shift the numbers around on paper doesn't mean it's a realistic solution.

  • some guy||

    We'd only have to chop non-entitlement spending by 80% if we wanted to fully fund the entitlement programs. Alternatively we could cut everything, including entitlement spending by a smaller amount. But, honestly, do you think we even get $300 billion in value out of the government as is?

  • ||

    Okay, so let's talk about the sudden, sharp cuts to Social Security and Medicare that would be required--do you think that's going to happen any time soon? The way we've always "addressed" the issue of long-term solvency in our Social Security system is by moving back the retirement age--for people slated to retire several decades in the future. Such an approach makes sense in the long run, but if we refuse to raise the debt ceiling, we need to save money TODAY. In other words, we need to slash Grandma's next SS check by a significant percentage. Laying aside the moral debate--do you think Congress is likely to do that? Grandma VOTES.

    "But, honestly, do you think we even get $300 billion in value out of the government as is?"

    Yes. I think we get significantly less than $3.8 Trillion in value from the federal government, but substantially more than $300 Billion.

    I'm not one of those people who claim that the national debt is no big deal, and I'd like to see some serious cuts in federal spending, on the order of hundreds of billions of dollars. I hope the Republicans in the House make these cuts a condition of any increase in the debt ceiling. I'd like to see the deficit reduced, and *eventually* eliminated. However, I think that the roughly $1.5 trillion spending cut that would be forced by refusing to raise the debt ceiling would create too much of a shock for our economy to handle right now. A hardcore alcoholic can die from going "cold turkey" on the booze, and an economy so dependent on the federal teat would probably sustain more harm than good from a sudden withdrawal. We need to *transition* large segments of our economy away from dependence on wasteful deficit spending to more productive, efficient, market-driven activities. However, the dynamics of adjustment take time--lets not kid ourselves into thinking that the current beneficiaries of government largesse will suddenly put their energies to productive use as soon as they're cut off from federal money.

  • ||

    If Grandma has to take a 20% hit on her SS check, then, considering that her kids may be taking a 100% hit on their income by losing their jobs due to feckless government spending starving out private investment -- why, I'm kind of cool with that.

    Where do we get the notion that only Grandma should have her income protected when times are tough? Why do we favor a retired 66-year-old who probably owns her own house and has nobody to support but herself over, say, a 38-year-old recently laid off with a fat mortgage on a worthless house and 2 kids to support?

  • ||

    As I said in my last reply:

    "Laying aside the moral debate--do you think Congress is likely to do that? Grandma VOTES."

    I'm not getting into the issue of whether or not SS beneficiaries SHOULD have to relinquish part of their benefits; my whole point is that it "ain't gonna happen." Senior citizens are probably the most powerful voter block in the U.S., and just about any Congressperson who votes for a reduction in their benefits is committing political suicide.

    Current SS spending is effectively off limits for purposes of spending cuts. Identifying reasons why it shouldn't be immune won't change the fact that it is.

  • Bill||

    The first thing we need to do is pass a law that says once you are on public assistance (including S.S.), you can no longer vote!

    We just schedule the votes for this new law in the evening when all the old people are asleep.

    simple.

  • ||

    Bingo. In a financial deficit position, only those who fund the government get to vote on whom shall decide how to spend the money. Great policy.

  • CE||

    The first thing we need to do is pass a law that says once you are on public assistance... you can no longer vote!

    My idea is to give everyone one vote for each one thousand dollars they pay in net taxes. Earn 80K a year in a government job, and pay 20K in taxes? No votes for you! Earn 80K a year and pay 20K in taxes? You get 6 votes. Earn 40K a year and pay 10K in taxes? 3 votes.

  • Appalachian Australian||

    Why aren't families taking care of grandma?

    My grandma lives in my parents' house and my mother takes care of her night and day. Her SS checks help, but the bulk of her money comes from my deceased grandfather's miner's pension, since, y'know, he actually had the foresight to save up money in something besides SS.

    If you're elderly and you don't have family looking out for you, you're probably going to rot away in a nursing home anyway (whilst the nursing home robs Medicare of $50k a year).

  • Bill||

    I don't think that is her argument. She's just saying that not raising the debt limit would not immediately be catastrophic. Perhaps then we could negotiate some serious budget cuts before raising the debt limit a smaller amount in a few months. Meanwhile, by not raising it now, there is real pressure to actually make some tough bipartisan decisions.

  • Gregory Smith||

    How the hell does spending public money help the economy? I work for a private company, I have a private car, I buy private gas, I eat private food... The only thing Obama could to do help me would be to lower my taxes, yet will he do that? No, he'll simply spend more and then demand "shared sacrifice." Hope and change my ass.

    The Taxpayer-Funded Lifestyle of Jimmy Carter.
    http://libertarians4freedom.bl.....jimmy.html

  • radu||

    This his whole thing reminds me of the Seinfeld reservation bit. To paraphrase US knows how to set a debt limit but not how to respect it. And respecting it is the whole point of a debt limit. Anyone can just set debt limits. Its easy, you write a number on a piece of paper.

  • ||

    As I understand it, the debt ceiling was not originally started to cap congressional spending. Prior to approving a debt ceiling, congress had to vote on every bond issued by the Treasury Dept. That was too much hassle for congress, so they chose to meet their constitutional requirement by adopting a debt ceiling. It is an early example of congress delegating its authority like they do now letting the executive branch make regulations.

  • ||

    If you were considering loaning a nation money, would you think them more likely to default if they keep going more and more into debt, or if they break promises to its citizens regarding government benefits such as pensions/welfare?

    As a lender, I'd prefer they stop going into debt and reduce welfare spending.

  • ||

    Also consider the possibility the nation will just inflate its currency. Under which scenario would you prefer to loan them money? Again I'd prefer they reduce their spending and not go further into debt.

  • CE||

    So basically, the debt, and the debt "limit" have gone vertical since 2002. This baby's going down....

  • CE||

    ...our ability to remain solvent...

    What you mean "our", kemo sabe?

  • ||

    Important question: Is the graph: "increasing the debt limit - AGAIN" adjusted for inflation? The fact that it doesn't specify that makes me not trust it. I'd like to see what that graph looks like both with and without adjustment..

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