How the Debt Ceiling Works

By: Dave Roos  | 

U.S. Treasury
The U.S. Treasury is in charge of paying for all of the government's outstanding bills. U.S. Treasury

If you're curious how much it really costs to run a modern Western superpower, look no further than a fascinating document issued every single day by the U.S. Treasury called the Daily Treasury Statement. The statement is a concise, daily reckoning of exactly how much the U.S. federal government spent that day — rounded off to the nearest million, of course — and how much it pocketed in revenue. It's also a handy way of understanding the national debt and this mysterious thing called the debt ceiling.

Let's look at a single day in greater detail: Sept. 23, 2021. On this average Thursday, the federal government took in $115.4 billion in revenue from sources like:

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  • Individual Income and Employment Taxes, Not Withheld ($7 billion)
  • State Unemployment Insurance Deposits ($331 million)
  • Medicare Premiums ($677 million)

On that same day, the government spent $214.2 billion on items like:

  • Coronavirus Relief Fund ($25 million)
  • Defense Vendor Payments ($2.9 billion)
  • Supplemental Nutrition Assistant Program (SNAP) ($434 million)

That's one day. On that day, the government spent $98.7 billion more than it earned. That $98.7 billion amounts to the budget deficit for Sept. 23, 2021. When you add up all of those budget deficits, plus some extra money that the government borrows from itself (don't ask), you get a number called the national debt. To date the national debt stands at about $28.4 trillion.

That's where the debt ceiling comes in. It's the maximum amount of debt the Department of the Treasury can issue. There was no limit on the debt ceiling because of the Bipartisan Budget Act of 2019, which suspended it through July 31, 2021. But Aug. 1, 2021, the debt ceiling reset to the previous amount of $22 trillion, which was set in 2017.

Why is the government only allowed to borrow $22 trillion? Can't the Treasury just print more money? And what does this have to do with spending cuts or tax increases? Keep reading to get the full story on the debt ceiling, what it is, where it came from, and why it's such a political thorn in America's side.

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What Is the Debt Ceiling?

National Debt
When you add up all of the U.S. government's budget deficits, you get what we call the national debt. Today that number stands at around a whopping $28 trillion. zimmytws/Shutterstock

As the Daily Treasury Statement shows, the U.S. federal government spends an obscene amount of money every day to pay for hundreds of programs and services, from national defense to education to disease control and prevention.

The problem is that the federal government doesn't earn enough in income tax and other revenue to cover the cost of running the country. The result is that pesky budget deficit. Technically, Congress could erase the budget deficit by passing steep spending cuts, raising taxes or both, but that has proven politically problematic.

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Instead, the government covers the budget deficit by borrowing money. The president doesn't walk down to a Bank of America and ask for a $1 trillion loan. The better way is to sell U.S. Treasury securities to individuals, banks, corporations and even foreign governments. When you buy a Treasury bond, you are essentially lending money to the government at a low interest rate. China and Japan each owned more than $2.3 trillion in U.S. Treasury securities as of July 2021 [source: U.S. Treasury Dept.].

When you add up all of the money that the federal government has borrowed from other countries, individuals and even itself , you get the national debt. The national debt doubled from $5.7 trillion in 2000 to $10 trillion in 2008 and now stands at more than $28 trillion.

Which brings us to the debt ceiling. Some folks compare the debt ceiling to the credit limit on your credit card. If your card has a $10,000 credit limit, then you can only charge $10,000 on your card without paying down the outstanding balance. In much the same way, the debt ceiling is a limit on how much the government can borrow to pay for its programs and services.

But there are key differences between the debt ceiling and a credit limit. The bank sets your credit limit because it decided that it's too risky to lend you more than $10,000. On the flip side, the foreign governments and individuals that buy U.S. Treasury securities can't get enough U.S. debt [source: Hirsch]. To them, it's literally the most reliable investment in the world, backed by the "full faith and credit" of the U.S. government.

In the case of the debt ceiling, the credit limit is imposed by the borrower, not the lender. Congress sets the debt ceiling, not our foreign or domestic creditors. But why would Congress want to lower U.S. debt if the well of low-interest credit never runs dry? To answer that question, we first need to study the history of the debt ceiling.

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History of the Debt Ceiling

U.S. treasury bonds
Selling U.S. treasury bonds is one way the U.S. federal government borrows money from other countries. Geri Lavrov/Getty Images

When the United States was younger, Congress held a much tighter grip on the national "credit card." In most cases, the Treasury could not sell securities — aka borrow money — without explicit approval of Congress. When the Treasury needed to borrow money, Congress determined what types of securities to sell — short-term or long-term — how many, and at what interest rates [source: Austin].

Strict congressional oversight was lifted temporarily during times of war. The War Revenue Act of 1898, for example, gave the Treasury flexibility to borrow up to $500 million by selling a combination of short- and longer-term securities. This money was used to fund the Spanish-American War and represented the first time that the Treasury could freely borrow up to a fixed limit or debt ceiling.

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The First and Second Liberty Bond Acts of 1917 set similar debt limits to help fund the U.S. entry into World War I [source: Austin]. Gradually, the Treasury was given more and more freedom to determine which securities would generate the most revenue for the least amount of interest.

In the 1920s and 1930s, Treasury Secretaries Andrew Mellon and Henry Morgenthau argued for even more flexibility to manage the nation's debt. In 1939, Morgenthau and President Franklin Roosevelt convinced Congress to create the first aggregate debt limit, meaning a debt ceiling that covered all federal debt [source: Austin]. As long as the Treasury stayed below that debt limit, it was free to borrow as it saw fit to pay the country's bills on time.

This was the birth of the debt ceiling as we know it. Under this arrangement, Congress approves spending bills and the Treasury figures out how to pay for them. Treasury is allowed to borrow up to the debt ceiling without asking Congress for permission to borrow more. But every so often, Treasury bumps up against the ceiling, and Congress must vote to raise it. Since the end of World War II, Congress has voted 98 times to modify the debt limit to accommodate the changes in federal debt levels — 21 of those have been since 2001.

In recent years, some congressmen and women have threatened to block passage of debt ceiling increases unless cuts were made to government spending. To understand why these threats are so politically powerful, let's look at the potential damage to both the U.S. and global economy if Congress failed to raise the debt ceiling.

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What Happens If Congress Doesn't Raise the Debt Ceiling?

Stock Market Graph and dollar bill
The United States has never defaulted on its debt. On Tuesday, Sept. 28, U.S Federal Reserve Chairman Jerome Powell and Treasury Secretary Janet Yellen told lawmakers that if that occurs, it would have devastating consequences on the economy. corlaffra/Shutterstock

To understand what would happen if the U.S. Congress didn't raise the debt ceiling, let's go back to the credit card analogy. If you borrow the maximum $10,000 allowed by your credit card, you will need to do everything in your power to avoid going into default, which would ruin your credit rating. You can try to drastically cut your personal spending, get a second or third job to increase revenue, or borrow the money from someplace else, probably at a higher interest rate.

If Congress decides not to raise the debt ceiling, as Senate Republicans did Sept. 27, 2021, the federal government runs the same risk of going into default and damaging its credit rating. Up until now, the world has treated the U.S. Treasury like an international piggy bank, the safest place to invest money during an era of global economic uncertainty. When a foreign government needs cash, it can simply redeem a few million dollars in U.S. Treasury bonds.

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But what if the Treasury doesn't have enough money to back its bonds? At worst, it could default on some of its debts, which could send global markets into a panic. But even if the government avoids a full default, it could lose its AAA credit rating. That means that creditors could demand higher interest rates. When the base interest rate on Treasury bonds goes up, other interest rates are likely to follow, like those attached to home mortgages or business loans. Higher rates would discourage investment, creating a huge drag on economic growth in the U.S.

Also, if Congress opted not to raise the debt ceiling, it would be forced to live within a budget. That would likely mean deep, across-the-board spending cuts and massive scale downs of popular programs like Social Security and Medicare. It would also likely mean raising taxes significantly.

Until those spending cuts and tax hikes took effect, the Treasury would have to decide which bills to pay first with its dwindling funds: interest on the national debt or Social Security payments? Tax refunds or Medicare reimbursements? All of these scenarios would likely trigger a massive political backlash from voters in both parties.

That's our brief explanation of how the debt ceiling has evolved from a convenient instrument for managing government borrowing into a political powder keg. For lots more information on the national debt, personal budgeting and credit cards, check out the related links on the next page.

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Originally Published: Oct 15, 2013

Lots More Information

Related Articles

  • Austin, D. Andrew "The Debt Limit: History and Recent Increases." Congressional Research Service. Nov. 2, 2015. (Sept. 28, 2021) http://www.fas.org/sgp/crs/misc/RL31967.pdf
  • Cochrane, Emily. "Republicans Block Government Funding, Refusing to Lift Debt Limit." The New York Times. Sept. 27, 2021 (Sept. 28, 2021) https://www.nytimes.com/2021/09/27/us/politics/republicans-block-government-funding-bill-debt-limit.html
  • Congressional Budget Office. "Federal Debt and the Statutory Limit, July 2021." July 2021 (Sept. 28, 2021) https://www.cbo.gov/publication/57371
  • Congressional Research Service. "The Debt Limit." March 17, 2021 (Sept. 28, 2021) https://sgp.fas.org/crs/misc/IF10292.pdf
  • Daily Treasury Statement. "Cash and debt operations of the United States Treasury." Sept. 24, 2021 (Sept. 28, 2021) https://fsapps.fiscal.treasury.gov/dts/files/21092400.pdf
  • Davidson, Adam. "Our Debt to Society." The New York Times. Sept. 10, 2013. (Oct. 14, 2013) http://www.nytimes.com/2013/09/15/magazine/our-debt-to-society.html?pagewanted=all&_r=0
  • Federal Reserve. "Factors Affecting Reserve Balances." Oct. 10, 2013. (Oct. 14, 2013) http://www.federalreserve.gov/releases/h41/Current/
  • Hirsch, Paddy. "Debt ceiling is like a credit card? Think again." Jan. 18, 2013. (Oct. 14, 2013) http://www.marketplace.org/topics/world/whiteboard/debt-ceiling-credit-card-think-again
  • Rappaport, Alan. "Explaining the U.S. Debt Limit and Why It Became a Bargaining Tool." The New York Times. Sept. 27, 2021 (Sept. 28, 2021) https://www.nytimes.com/2021/09/27/us/politics/us-debt-ceiling.html
  • Sherter, Alain. "Debt ceiling: Understanding what's at stake." CBS MoneyWatch. Oct. 7, 2013. (Oct. 14, 2013) http://www.cbsnews.com/8301-505123_162-57606253/debt-ceiling-understanding-whats-at-stake/
  • U.S. Department of the Treasury. "Debt Limit: Myth v. Fact." May 2011. (Oct. 14, 2013) http://www.treasury.gov/initiatives/Documents/Debt Limit Myth v Fact FINAL.pdf
  • U.S. Department of the Treasury. "Historical Debt Outstanding — 2000 – 2012." (Oct. 14, 2013) http://www.treasurydirect.gov/govt/reports/pd/histdebt/histdebt_histo5.htm
  • U.S. Department of the Treasury. "Major Foreign Holders of Treasury Securities." (Oct. 14, 2013) http://www.treasury.gov/resource-center/data-chart-center/tic/Documents/mfh.txt
  • Wessell, David. "The Debt Ceiling Explained: Why You Should Care." The Washington Post. Feb. 4, 2013. (Oct. 14, 2013) http://live.wsj.com/video/the-debt-ceiling-explained-why-you-should-care/40415F7F-C0EB-4048-9612-42A22EB77D66.html#!40415F7F-C0EB-4048-9612-42A22EB77D66

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