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Debt Ceiling: What Is It and What Happens If We Breach It?

Debt Ceiling: What Is It and What Happens If We Breach It?

May 22, 2023

When the federal debt ceiling was established by Congress in 1917, its purpose was to make it easier for the US Treasury Department to manage the country’s debt. More specifically, it allowed the Treasury to take on debt and issue bonds without needing Congress’ direct approval – as long as the amount it borrowed stayed below the debt ceiling. While the debt ceiling has always served to limit the amount of debt that the Treasury can take on, this cap aspect has become more prominent as government spending has continued to balloon over the decades. Nowadays, whenever a debt ceiling deadline approaches, many start to worry about what will happen if the government breaches the ceiling. What if Congress doesn’t raise the limit in time and the Treasury defaults on its obligations? How will this affect the economy?

This article explains the debt ceiling in detail and why it’s become so controversial, as evidenced by the use of language like ‘debt ceiling crisis,’ ‘standoff,’ and ‘battle’ in the news. Learn why people keep bringing up the Republican debt ceiling cuts, what the possible ramifications of a default might be, and how the Treasury might handle a situation when it can’t afford all of its obligations.

What is the Debt Ceiling?

Let’s start by discussing exactly what the debt ceiling is and why it’s become such a hot debate topic over the years. In basic terms, the debt ceiling is a limit set by Congress on how much money the government (US Treasury) can borrow to finance its budget deficits. This limit is raised periodically to accommodate the government's growing debt.

The US technically hit its debt ceiling on January 19, 2023. The Treasury has since implemented “extraordinary measures,” also known as special accounting maneuvers, to keep paying its bills so it can avoid a default. Certain government investments have been temporarily put on hold in the meantime. The new debt ceiling deadline is June 1st, according to Treasury Secretary Janet L. Yellen. If it’s not raised by then, the government will most likely run out of money.

The debt ceiling has been a topic of much debate in recent years (just Google “debt ceiling news” or “debt ceiling 2023” to see evidence of this), with some arguing that it is a necessary check on government spending and others calling for its abolition. Proponents of the debt ceiling argue that it promotes fiscal responsibility and prevents the government from borrowing excessively, while opponents say that it is a needless constraint on the government's ability to manage its finances. Throughout the years, different political parties have used debt ceiling deadlines to negotiate and attempt to push through certain spending cuts and other concessions, which only adds to the controversy surrounding the limit. Despite this, the debt ceiling is a crucial aspect of fiscal policy that can have significant implications on the economy.

What are the Potential Impacts of a Default?

The US government frequently reaches its borrowing limit (debt ceiling), causing intense debates in Congress over whether to raise it. To put things into perspective, the debt ceiling – and the total national debt – was at $31.4 trillion in January 2023. While many think this amount of debt should be capped and potentially lowered using spending cuts, the impacts of not raising the debt ceiling could be severe.

For example, if Congress chooses not to raise the debt limit, the government will very likely default on its loans (i.e., not be able to pay them), which might cause the value of the US dollar to fall precipitously. Other countries might then question if it should remain a reserve currency. Moreover, a default may lead to a recession (which, in May 2023, already looms) – maybe even globally, likely causing volatility in the financial markets and a spike in unemployment.

Interest rates might also skyrocket, making it more expensive for people to borrow money for homes, cars, and other large purchases. Furthermore, US-issued debt could also drop in value if interest rates go up, depending on the length of the default episode. In all likelihood, the government would prioritize certain payments (like the bondholders who own US Treasuries), but no one knows for sure since this hasn’t ever happened or been tried before.

Ultimately, a default would likely damage the country's reputation and creditworthiness in the global market. As a result, many think that lawmakers must find a way to once again raise the debt ceiling to prevent these consequences.

What Might the Treasury Do If It Can’t Afford Its Obligations?

The US Treasury helps keep the country’s economy running smoothly. If a time comes when the Treasury cannot pay all of its obligations (e.g., a debt ceiling default), though this would be unprecedented and hard to predict, there are several potential ways the government might handle this. For example, as mentioned above, the department could choose to prioritize critical payments like Medicare and Social Security while delaying other payments. In addition, the government could take steps to increase its revenue and cut spending to reduce its deficit.

In the prioritization scenario, if the Treasury chose to make interest payments, it would likely have to cut “other outlays” by about -25% per month on average. This would be the case because, per research group Brookings Institution, “close to 25 cents of every dollar of non-interest outlays are expected to be financed by borrowing in 2023.” If the government decides to prioritize both Social Security and interest payments, on the other hand, the Brookings Institution believes that other payments would likely need to be cut by around one-third. Since tax revenue varies month-to-month (these infusions of cash tend to be lower in the summer, for instance), the spending cuts the Treasury makes would also likely vary. 

When the US faced a similar situation in 2011, the government had a contingency plan in place. This plan dictated that the interest payments on Treasury securities would still be made on time (i.e., the securities wouldn’t default). The department planned to auction new securities (in the same amount so as not to increase the overall debt) to pay the principals as securities matured. In the meantime, the Treasury would delay other payments until it had accumulated enough money to cover a full day’s worth of obligations. This chain of events would likely lead to many legal challenges.

There has also been some talk of the Treasury potentially minting, issuing, and depositing a “collectible” trillion-dollar platinum coin to pay all its bills. Technically, the entity has the legal authority to do this, but the Treasury Secretary has said that the government might choose not to accept the deposit in this scenario. Others have put forth the idea that the Constitution’s 14th Amendment might enable the Treasury to ignore the limit altogether because it is required to meet all its obligations. Neither the trillion-dollar coin nor the 14th Amendment “solutions,” however, would likely be enough to prevent most of the economic turmoil and far-reaching consequences that are described above.

The Bottom Line: A US Default on Debt Would Likely Be a Big Deal

The federal debt ceiling is an intricate and complex issue that requires thoughtful consideration and action by those in Congress. When a deadline approaches, it's imperative that all sides come together to identify and put effective solutions in place that both manage the country's debt responsibly and keep the Treasury current with all its obligations. In this way, the potentially severe and long-lasting economic ramifications of a breached debt ceiling can hopefully continue to be averted.