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The U.S. Debt Ceiling Explained

By Austin Kilham · November 09, 2021 · 4 minute read

We’re here to help! First and foremost, SoFi Learn strives to be a beneficial resource to you as you navigate your financial journey. Read more We develop content that covers a variety of financial topics. Sometimes, that content may include information about products, features, or services that SoFi does not provide. We aim to break down complicated concepts, loop you in on the latest trends, and keep you up-to-date on the stuff you can use to help get your money right. Read less

The U.S. Debt Ceiling Explained

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

The debt ceiling only authorizes borrowing to cover existing obligations, it does not allow for new spending. Some worry that increasing the debt ceiling could have a negative impact on the U.S. economy over the long-term. Failing to do so, however, would have an immediate impact, if the United States went into default because it didn’t have the money to pay its bills.

In the past, huge Congressional fights over raising the debt ceiling have caused turmoil in the financial markets, bringing the country to the brink of default and prompted ratings agencies to consider downgrading U.S. debt.

What Is the Debt Ceiling?

The U.S. debt ceiling is the legal limit on how much money the U.S. federal government can borrow beyond what it already owes to fund government operations. The U.S. government owes nearly $30 trillion, which it accrues by issuing bonds. That includes more than $22 trillion owed to the public, including individuals, businesses, and foreign governments, and more than $6 trillion to itself, borrowed from government agencies, such as the Social Security Administration.

Recommended: Who Owns the US Debt?

When federal spending pushes up against this limit, Congress must vote to raise the debt ceiling. In August of 2021, the debt 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.

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 for borrowing. It also theoretically serves as a way to keep government spending in check.

However, there are also some drawbacks. Congress has always raised debt ceiling when necessary, which may dampen its power as a check and balance. And if Congress does not raise 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. Congress has raised or made changes to the debt ceiling nearly 100 times since World War II. Not every one of these instances has been a battle. Congress raised the debt ceiling three times under the Trump Administration with little conflict or fanfare.

What Happens if Congress Fails to Raise It?

Before the December 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 a number of consequences.

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

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

Interest rates for Treasuries 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 volatility in equity markets and bond markets globally, and push down the value of the U.S. dollar.

Recommended: What Is the US Dollar Index?

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 a total of $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.

Can Congress Get Rid of the Debt Ceiling?

Over the years, 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 Department of Treasury.

Congress could also repeal the debt ceiling entirely. For now, there are at least two bills in Congress that would change how the government managed the debt ceiling. One, 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, which would give the authority over the borrowing cap to the Treasury Department.

The Takeaway

A failure to raise the debt ceiling and a subsequent default could have a major 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.

Even if the debt ceiling continues to go up, growing national debt could lead to higher interest rates over time or lower stock returns, according to some economists. That makes it something to consider as you’re devising your investment strategy.

A great way to kick-off that strategy is by opening an investment account with SoFi Invest®. You can choose either an Active investing account, in which you choose your own asset allocation, or an automated account, which picks investments and adjusts them on your behalf.

Photo credit: iStock/William_Potter


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