The Facts About the Debt Ceiling

Separating economic myths from economic truths

Editor's Note: Reason columnist and Mercatus Center economist Veronique de Rugy appears weekly on Bloomberg TV to separate economic fact from economic myth.

Myth 1: If a deal is not reached by August 2, the U.S. will default on its debt.

Fact 1: The Treasury Department can prioritize payments in order to avoid a default.

The Treasury Department is due to pay off $30 billion in maturing short-term debt. But we also know that the Treasury has the ability to prioritize its payments and pay that particular $30 billion out of the $172 billion it collects in tax revenue. As the Bipartisan Policy Center has calculated, after paying $30 billion in interest payments in August, Treasury could, if it ceased all other functions (see page 13 of this document), also pay for Social Security, Medicare, unemployment benefits, and payments to defense contractors. Technically speaking, there is no need to default in the absence of a debt ceiling agreement.

This is not an ideal solution and it entails some significant risks (mainly timing difficulties), but it could be done if necessary.

In addition, the Treasury could sell some of its assets in order to pay the bills. That's an expensive option at this point, since it would probably mean selling them at a low price, but these are not normal times and a fire sale beats a default.

Myth 2: If the debt ceiling isn't raised the government won't be able to pay Social Security benefits.

Fact 2: There are approximately $2.6 trillion dollars in the Social Security Trust Fund. Those assets can be used to pay benefits. Furthermore, there is already trillions of dollars of interagency debt that counts toward the $14.29 trillion debt limit. Treasury Secretary Timothy Geithner could convert that interagency debt into publicly-held debt, preventing not only a technical default but also preventing any delay in government payments.

President Barack Obama has suggested that if the Treasury prioritized payments in order to prevent default on the debt, it might do so on the backs of seniors by not sending out their Social Security checks. This is a particularly troubling rhetorical move by the White House. As the president and his advisers know, there are ways for the government to pay these benefits—messy ways, yes, but still viable—in the absence of a debt-ceiling agreement. That's what the president should be saying rather than trying to scare seniors.

According to a Bipartisan Policy Center report, incoming revenue on August 3 will amount to $12 billion. At the same time, the government is scheduled to spend some $32 billion—most of it in the form of Social Security checks. How do we make up the difference?

First, remember how Social Security works. Starting now, the difference between payroll-tax revenue and Social Security benefits is made up by redeeming the IOUs in the Social Security Trust Fund. In order to pay back this IOU, Treasury has to borrow the money, which increases the debt held by the public by the same amount. In other words, if Treasury were to redeem the needed Social Security bonds and issue new marketable Treasury bonds to make good on them, it would be a one-for-one swap.

There is a potential glitch, however, having to do with whether Treasury has the authority to use payroll tax money to pay benefits rather than to "invest." According to Washington Post "Fact Checker" Glenn Kessler, the Treasury has done it before:

There is a technical wrinkle involving the fact that payroll taxes that are collected are supposed to be immediately turned into Treasury securities, but there could be ways around that, such as putting the monies in a noninterest bearing account, as during the 1985 debt crisis. "Although some of the Secretary's actions appear in retrospect to have been in violation of the requirements of the Social Security Act, we cannot say that the Secretary acted unreasonably given the extraordinary situation in which he was operating," the General Accounting Office later concluded….

Still, during the 1996 debt limit crisis, Treasury Secretary Robert Rubin announced that Treasury did not have sufficient funds to pay Social Security benefits. Congress rushed to pass a special law that said the Social Security benefits did not count against the debt limit. Was this designed to pressure the Republican-led Congress, or had even a shrewd operator like Rubin run out of options? However, Congress later that year passed a law, 121-104, that codified Treasury's authority to use Social Security trust funds to pay benefits and administration expenses in the event a debt ceiling is reached, which could give the administration the authority they need in the current crisis.

The Congressional Research Service has also explored this question in a series of reports this year. The answer is unfortunately inconclusive and buried in a footnote: "Under normal procedures Treasury pays Social Security benefits from the General Fund and offsets this by redeeming an equivalent amount of the trust funds' holdings of government debt. In order to pay Social Security benefits, and depending on the government's cash position at the time, Treasury may need to issue new public debt to raise the cash needed to pay benefits. Treasury may be unable to issue new public debt, however, because of the debt limit. Social Security benefit payments may be delayed or jeopardized if the Treasury does not have enough cash on hand to pay benefits."

Myth 3: The Treasury cannot use the Social Security Trust Fund to delay a default past August 2.

Fact 3: While the Treasury cannot use money from the Social Security Trust Fund, it can "disinvest" from other trust funds to pay for benefits.

Treasury can "disinvest" from some of its trust funds. Here's how it works according to the legislative director of the National Active and Retired Federal Employees.

Each day, the U.S. Treasury takes in several billion dollars for federal trust funds. For Social Security, these dollars come in the form of employer and employee payroll taxes. Federal employee and Postal Service contributions to the CSRDF [Civil Service Retirement and Disability Fund] also inject cash into the Treasury. Usually, this cash is immediately invested in nonmarketable government securities—to remain available to finance future benefits. But if a debt limit breach appears imminent, the Treasury Department could "underinvest" this revenue as it arrives. The trust funds would be given a temporary IOU that does not count against the debt ceiling, and the withholdings would be used to pay off the government's cash obligations until an increase in the debt ceiling could be settled.

The Treasury Department could also make cash available from the trust fund by "disinvesting" some of the money used to buy government bonds. Under this approach, bonds held on behalf of trust funds would be converted to cash earlier than normally needed. Like the "underinvestment" option, cash from this transaction would be used to pay federal obligations on a temporary basis.   

The disinvesting approach is a temporary accounting device that would help maintain the Treasury's cash flow.

According to the Government Accountability Office, the use of "disinvestment" to pay for benefits has been used during a previous debt-ceiling crisis:

In the past, Treasury has taken a number of extraordinary actions such as temporarily disinvesting securities held as part of federal employees' retirement plans to meet the government's obligations as they came due without exceeding the debt limit, until the debt limit was raised.

In fact, it happened during the last big debt-ceiling crisis in 1995-1996. According to the GAO, Treasury managed to remain technically under the debt ceiling and incurred about $138.9 billion in additional debt that normally would have been subject to the ceiling by disinvesting $46 billion in Civil Service fund securities in November 1995 and February 1996. The Treasury also suspended the investment of $14 billion in fund receipts in December 1995 and exchanged about $8.6 billion in Civil Service fund securities for Federal Financing Bank securities.

These actions, of course, are nothing more than short-term budget gimmicks. But they would allow the U.S. to avoid defaulting on the debt. Once these options are exhausted, however, there will be nothing left to do but raise the debt ceiling or dramatically cut government spending.

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