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The US Debt Ceiling, Explained

By Austin Kilham · October 27, 2022 · 5 minute read

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The US Debt Ceiling, Explained

The United States debt ceiling is the amount of money the country can legally borrow to pay its bills. Since the country’s fiscal obligations continue to grow, Congress periodically increases the debt ceiling so that the U.S. can issue bonds to have enough money to continue to operate.

Some experts worry that increasing the debt ceiling could have a negative impact on the U.S. economy over the long term, as it encourages the federal government to spend at supposedly irresponsible levels. However, other experts say that failing to raise the debt ceiling would have an immediate negative impact on the county’s finances because the U.S. would default on its debts since it doesn’t have the revenue to pay its bills.

In the past, there have been huge Congressional fights over raising the debt ceiling, which has caused turmoil in the financial markets, bringing the country to the brink of default and prompting rating agencies to downgrade U.S. debt.

What Is the Debt Ceiling?

The U.S. debt ceiling — sometimes called the debt limit — is the legal limit on how much money the U.S. federal government can borrow to fund government operations. The debt ceiling only authorizes borrowing to cover existing obligations; it does not allow for new spending.

The U.S. government owes more than $31 trillion, which it accrues by issuing bonds. That includes more than $24 trillion owed to the public, including individuals, businesses, and foreign governments, and nearly $7 trillion to itself, borrowed from government agencies, such as the Social Security Administration.

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When federal spending pushes up against this limit, Congress must vote to raise the debt ceiling. For example, in August of 2021, Congress reinstated the debt ceiling to about $28.5 trillion after suspending it in 2019. In October 2021, Congress voted to raise the debt ceiling limit by $480 billion to keep the government running through early December.

Most recently, Congress passed a $2.5 trillion increase in the debt ceiling in December 2021, which President Biden promptly signed, bringing the debt limit up to about $31.4 trillion. Analysts expect the U.S. government to hit the debt ceiling in January 2023, though the timing depends on the government’s spending and revenue levels.

Where Did the Debt Ceiling Come From?

Congress first enacted the debt ceiling in 1917 at the beginning of World War I through the Second Liberty Bond Act. That act set the debt ceiling at $11.5 billion. The creators of the debt ceiling believed it would make the process of borrowing easier and more flexible. In 1939, as World War II loomed on the horizon, Congress established a debt limit of $45 billion that covered all government debt.

Before the creation of the debt ceiling, Congress had to approve loans individually or allow the Treasury to issue debt instruments for specific purposes.

Benefits and Drawbacks of the Debt Ceiling

The debt ceiling has several advantages. It allows Congress to fund government operations and simplifies the process of borrowing. It also, theoretically, serves as a way to keep government spending in check because the federal government should consider the debt ceiling as it passes spending bills.

However, there are also some drawbacks. Congress has consistently raised the debt ceiling when necessary, which some analysts claim dampens the legislative branch’s power as a check and balance. And if Congress does not increase the debt ceiling, there is a risk that the government will default on its loans, lowering the country’s credit rating and making it more expensive to borrow in the future.

Debt Ceiling and Congress

Congress often finds itself embroiled in partisan battles over raising the debt ceiling. For example, during the Obama administration, there were two high-profile debt ceiling standoffs between the president and Congress. In 2011, some members of Congress threatened to allow the U.S. government to hit the debt ceiling if their preferred spending cuts were not approved. This standoff led Standard & Poor’s, a credit rating agency, to downgrade U.S. debt from a AAA to a AA+ rating.

Moreover, in 2013 there was a government shutdown when members of Congress would not approve a bill to fund the government and raise the debt ceiling unless the president made their preferred spending cuts. But this standoff ended after 16 days when Congress finally approved a spending package and a debt ceiling increase partially due to the potential for a further downgrade of U.S. debt.

However, only some debt ceiling increases have been a partisan battle. Congress has raised or made changes to the debt ceiling nearly 100 times since World War II, usually on a bipartisan basis. And Congress raised the debt ceiling three times under the Trump Administration with little conflict or fanfare.

What Happens if Congress Fails to Raise the Debt Ceiling?

Before the January 2023 deadline, Congress must vote again on a long-term solution for raising the debt ceiling. If they can not reach an agreement, there could be several consequences.

The government will swiftly run out of cash if it can not issue more bonds. At that point, the money the government has coming in would not cover the millions of debts that come due each day. The government may default, at least temporarily, on its obligations, such as pensions, Social Security payments, and veterans benefits.

A U.S. government default could also have a ripple effect throughout the global economy. Domestic and international markets depend on the stability of U.S. debt instruments like Treasuries, which are widely considered among the safest investments.

Interest rates for Treasury bills could rise, and interest rates across other sectors of the economy could follow suit, raising the borrowing cost for home mortgages and auto loans, for example. A default could also create stock volatility in global equity markets, turmoil in bond markets, and push down the value of the U.S. dollar.

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Even the threat of a default can have serious economic ramifications. In 2011, delays in raising the debt limit increased the cost of borrowing by $1.3 billion, according to the U.S. Government Accountability Office estimates.

What Are Extraordinary Measures?

When the government hits the debt limit, there are certain “extraordinary measures” it can take to continue paying its obligations. For example, the government can suspend new investments or cash in on old ones early. Or it can reduce the amount of outstanding Treasury securities, causing outstanding debt to fall temporarily. These accounting techniques can extend the government’s ability to pay its obligations for a very short amount of time.

Once the government exhausts its cash and these extraordinary measures, it has no other way to pay its bills aside from incoming revenue, which doesn’t cover all of it. Revenue from income tax, payroll taxes, and other sources only cover about 80% of government outlays, according to the U.S. Treasury.

Can Congress Get Rid of the Debt Ceiling?

As noted above, the debt ceiling debate has become fertile ground for partisan fighting in Congress, but theoretically, it doesn’t have to be that way. For example, Congress could give responsibility for raising the debt ceiling to the president, subject to congressional review, or pass it off to the U.S. Treasury. Congress could also repeal the debt ceiling entirely.

For now, two bills in Congress would change how the government manages the debt ceiling. End the Threat of Default Act, introduced in May 2021 by Democratic Senators Chris Van Hollen of Maryland, Brian Schatz of Hawaii, and Michael Bennet of Colorado, would eliminate the debt ceiling entirely.

Democratic House members Brendan Boyle of Pennsylvania and John Yarmouth of Kentucky introduced the Debt Ceiling Reform Act in September 2021, eliminating the debt ceiling and transferring borrowing authority to the Treasury.

The Takeaway

A failure to raise the debt ceiling and a subsequent default could have a significant impact on financial markets, from increased volatility to a decline in the value of the dollar to a lower national credit rating or even a recession. Given such consequences, it’s likely that Congress will continue to find ways to raise the debt ceiling, although political battles around the issue may continue.

And even if the debt ceiling continues to go up, the growing national debt could lead to economic instability, according to some economists. That makes it something to consider as you devise your investment strategy, as this economic stability would likely impact financial markets.

A great way to kick off that strategy is by opening an investment account with SoFi Invest®. With a SoFi online brokerage account, you can build a portfolio suited to your financial needs by trading stocks, exchange-traded funds (ETFs), and cryptocurrency with no commissions for as little as $5.

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Photo credit: iStock/William_Potter

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