The Debt Limit Lives To Fight Another Day
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The US government debt limit seems to have very few friends in Washington, but no one seems—yet—to be able get rid of it.
This was evident recently when Congress was about to pass a seemingly bipartisan, roughly 1,500-page spending bill to keep the government funded for a few more months—and thus through the end of the Biden Administration. Objections to the bill were raised by President-elect Trump, some Republicans (many in the Freedom Caucus in the House), and by Elon Musk, the world’s richest man, largest contributor to President Trump’s re-election campaign, and co-head of the soon-to-be-formed Department of Government Efficiency (DOGE).
Musk objected to many of the spending provisions in the bill—like a minor Congressional pay raise—and some provisions that were not actually in the bill—like supposed money to fund a new football stadium in Washington.
The result was that the bipartisan spending bill, which was thought to be certain to be approved before the holidays did not pass, principally because of Musk’s objections (which were presumed to carry the support of Trump).
As part of the effort to defeat the original bipartisan bill, President-elect Trump also weighed in on one particular matter, something not addressed directly by Musk. Specifically, Trump wanted to have the existing debt limit of the United States extended for two years—or past the next mid-term elections. The initial bipartisan bill had not dealt with the debt limit, which was likely to be breached in January 2025 without further legislative action to extend it.
After a revised, much smaller bill—designed in large part to accommodate Musk’s concerns—was defeated, a second further revised and also much-reduced spending bill—just 100 pages in length—was passed. President Biden signed that bill into law on December 21, 2024.
During the negotiations on the revised spending bill, the President-elect indicated that he would actually liketo see the debt limit completely eliminated—thereby having to avoid the “Perils of Pauline” exercise that occurs every year or two, when the existing debt limit is about to be breached. However, the revised bill did not include any provision relating to the debt limit, which means that the existing debt limit is still in effect—and essentially provides enough debt capacity until late January 2025—according to Secretary of the Treasury Janet Yellen.
That presents real challenges. President Biden will leave office on January 20th. A new Congress was sworn in on January 3rd, following the re-election of Speaker Mike Johnson. Can the speaker put together a debt limit extension that will please enough Democrats and Republicans to pass (and also meet President Biden’s approval)? Suppose President Trump wants to eliminate the debt limit completely and pushes for that? Can that occur, without scaring financial markets that there are not debts limits any longer? Or, would the markets actually be happier, because the government will not in the future have to go through political fights and uncertainties about raising the debt limit?
On two occasions, when the fight over passing a debt limit extension was so protracted that markets thought a breach might occur, there were consequences even though debt limit raises were passed at the last minute. In 2011, S&P Global Ratings reacted by downgrading the US credit rating. And in 2023 another last-minute passage of an extension resulted in a credit downgrade of the US debt by Fitch Ratings.
A fair question might be asked: is this any way to run a country—one whose financial actions set the standards for the world’s financial system?
Clearly not, but the debt limit is like the weather: everyone talks about it—often with complaints, but no one seems to be able to do anything about it.
The current situation raises a number of other questions about the debt limit. Let me try to provide some basic answers.
1. What would actually happen if the debt limit was breached, and the United States did not have authority to pay its bills or meet the interest and principal payments on its debt?
No one really knows, though the near universal presumption is that the US financial system would collapse, and with it the entire global economy. And as goes the US, it is presumed other countries would follow suit and have non-functioning financial systems and economies.
2. Why does the United States have a debt limit?
The United States government has had debt through almost its entire existence. The country started with debt left over from fighting the Revolutionary War. Alexander Hamilton thought the US government should be responsible for the payment of this debt, which was largely incurred by the Northern colonies. (The Southern colonies had largely paid off their debts before the US government was established under the Constitution, about four years after the War ended.)
Hamilton thought that the credibility of the United States in debt markets in the future would be enhanced if these pre-Constitution debts were assumed by the new federal government. At a dinner held between Alexander Hamilton, James Madison, and Thomas Jefferson, it was agreed that the debt would be assumed by the government, in return for which the new capital of the government would be established in the South. And that is why the capital moved from New York to Philadelphia, and then to a site selected by George Washington–what is now Washington, DC.
And the US government has had debt ever since–except in 1835, when Andrew Jackson ended the Second Bank of the United States and had all of the country’s debts extinguished.
When the United States went through the Civil War, debt began to rise to what was then a significant level. (Before the Civil War, US debt was about $65 million; the cost of the War increased US debt to about $3 billion—an increase of roughly 4000%.)
And when World War I arose, the United States again began to increase its debt levels. Prior to that, debt was incurred by various parts of the US government in different ways, but there was not a single consolidated debt account—and thus no single debt limit. But Congress directly approved each debt issuance in effect by passing specific legislation authorizing that debt. The US Treasury did not have the authority to issue debt whenever it felt a need to do so.
That changed in 1917, in anticipation of the considerable debt likely to be incurred fighting World War I, and the need for that debt to be incurred on a relatively rapid basis. Specifically, Congress passed a debt limit in connection with very specific legislation—the Second Liberty Bond Act—and that was the closest the country had come to a debt limit in the current sense.
But not until World War II did Congress set a consolidated government debt limit, recognizing that it could not possibly move quickly enough to approve all of the debt needed by various parts of the government. That limit was $45 billion, and the Treasury was given wide authority to incur debt when and as needed, provided that the total was not above $45 billion.
Since that time, the US government has approved more than 100 debt limit increases. And debt limit increases have occurred in all combinations of government—when Republicans control the White House and Congress, when Democrats control the White House and Congress, and when there is a split government in all combinations. No one party can say it is fighting debt limit increases by always blocking them. The typical pattern is that the party controlling the White House, and thus with the responsibility for running the country’s finances, seeks a debt extension whenever one is needed.
That said, in recent years, the Freedom Caucus in the House has been consistently against passing debt limit extensions and have sought spending cuts roughly equal to the level of the proposed debt limit increases. That has not met any measurable success.
3. How do other countries deal with debt limit extensions?
The US is the only country, other than Denmark, with a nominal debt limit. And in Denmark, the actual debt is a fraction (about 15%) of the debt limit.
4. Why does this problem keep arising in the United States?
Each time there is a debt limit increase, the increase is set at a level which will enable the United States to keep borrowing for a relatively short period—typically a year or two. So, a new debt limit will be needed in the not-too-distant future. The enables an administration, and members of Congress, to feel the debt is still somewhat under their control—a blank check is not being given to the Treasury to borrow whatever amount it wants.
5. How did the US government get into this predicament?
This answer depends on one’s perspective. Those on the left side of the political spectrum would say the country’s basic social needs—retirement, health benefits, and education, for instance, are a necessary part of what a government should be doing. And the requisite services should be paid by increasing taxes on corporations and the wealthy. Those on the right side of the political spectrum would say that the country should bolster national security expenditures, incentivize businesses to innovate and produce, and shrink the size of government.
These conflicting views have produced no consensus on spending or debt in the US government, and the result is the debt train inexorably keeps moving forward. To illustrate:
When I left government service in 1981, the federal budget for fiscal year 1981, as proposed by President Carter before leaving office, was $616 billion, with a projected deficit of roughly $16 billion. The total indebtedness of the US government was around $908 billion.
Since that time, federal expenditures have increased dramatically, in large part because the United States has fought wars in Iraq and Afghanistan, supported our allies’ wars elsewhere, increased Social Security benefits, expanded healthcare benefits under the Medicare and Medicaid programs, approved large muti-year tax cuts under several presidents, and dealt with the impacts of the Great Recession and the Covid-19 pandemic. Furthermore, the population of the United States has increased by nearly 110 million since 1980, and individuals are living significantly longer (impacting Social Security and Medicare). In 1980, life expectancy in the US was 73.6 years; now it is 77.4 (but was even higher before the 2020 pandemic).
Figure 1 illustrates that debt does not stop growing for any president.
Throughout these forty-four years, the United States has run deficits in every single year, except three out of the final four Clinton years and the first year of George W. Bush’s first term—periods when surpluses were achieved, in large part because of the spending constraints agreed to under the Deficit Reduction Act of 1993 and the Balanced Budget Act of 1997. (For those too young to remember, a budget surplus is when the US government takes in more revenue than it spends. When that will next occur is unknown, and the chance of seeing it may be as likely as a sighting of Halley’s Comet.)
Figure 1.
Even if the DOGE works miracles, it is hard to see how the federal budget will get to a balance or surplus in the near future. About 80% of the US budget is defense spending (a bit of a sacred cow to many Republicans) and entitlement spending for Social Security, Medicare, Medicaid, and interest on the federal debt—now at $36 trillion. (The interest on this debt is now expected to exceed federal expenditures on defense next year—often said to be a danger sign for a country’s stability and security.)
But even if the DOGE can work miracles, nothing miraculous can happen by late January, when the United States will begin to run out of the ability to keep from defaulting on existing obligations.
So what solutions are there in the near term?
I see really just three:
1. Extend the debt limit for six to twelve months — A solution likely to be supported by the Democrats in Congress, who fear that too large a debt increase will enable President Trump and the Republicans to cut taxes significantly without having to worry about breaching the debt limit when doing so.
2. Extend the debt limit to the end of November 2026 – That pushes the debt limit past the next mid-term elections and would eliminate the need for Republicans leery of voting for a debt limit increase before their next election.
3. Eliminate the debt limit completely – This seems the most sensible option, because the debt limit does not have any impact on reducing the US deficit or indebtedness, as seen above, and would enable the United States to be honest about the reality that there is no true debt limit. Hopefully something like this could be coupled with a serious effort to get the federal deficit—now running at close to $2 trillion per year—under better control.
Pray for number three and assume number one.