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United States: Return of the US debt ceiling

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  • After being suspended for about a year, the debt limit returned on March 2. However, the Treasury Department will take extraordinary measures that could delay a federal government default to September or October.
  • Consequently, raising the debt limit could become tied to the budget negotiations for fiscal year 2020, which starts on October 1, 2019.
  • If no budget deal is reached before October 1 there are two possibilities: either Congress adopts a continuing resolution (triggering automatic spending cuts) or the government shuts down again.
  • Therefore, we may be heading toward a game of chicken between Republicans and Democrats with the threat of a government default and either sequestration or another government shutdown.

Introduction

While another government shutdown was averted in February, the debt limit returned in March. In early 2018, the Bipartisan Budget Act of 2018 suspended the debt limit through March 1, 2019. During this period, the Treasury Department was allowed to borrow what it needed to meet existing commitments. However, the amount of debt on March 2 will be the upper limit for the Treasury going forward. This does not mean that the government will go into default in March. The Treasury is able to take extraordinary measures that may delay a default to September or October. However, this means that the discussion about the debt limit could become tied to the negotiations about the budget for fiscal year 2020, which starts on October 1, 2019. The tricky aspect of the FY2020 budget negotiations is that if no budget agreement is reached before October 1, and Congress will have to pass a continuing resolution, automatic budget cuts will take place through sequestration. What's more, if Congress also fails to pass continuing resolution, another government shutdown will take place in October. Therefore, we may be heading toward a game of chicken in Washington DC in September with the threat of a government default and either sequestration or another government shutdown.

Debt limit

In the US, the amount of money the Treasury Department is allowed to borrow is restricted by a debt limit. Prior to 1917 Congress was required to approve each issuance of debt. To smoothen the process, the Second Liberty Bond Act set a debt limit at $11.5 billion. Since then the debt ceiling has been increased about 100 times. Sometimes, the debt limit is temporarily suspended. In fact, in early 2018, the Bipartisan Budget Act of 2018 suspended the debt limit through March 1, 2019. Consequently, the amount of debt on March 2, about $22 trillion, will be the new debt limit.

Figure 1: Total public debt
Figure 1: Total public debtSource: Macrobond

However, this does not mean that the government will go into default in March. The Treasury is able to take extraordinary measures that may delay a default to September or October, depending on the outcome of the April tax season in particular. Tax revenues from corporations and individuals tend to peak around the April 15 filing deadline. While the CBO currently expects the Treasury to run out of cash ‘near the end of this fiscal year or early in the next one’, if tax revenues are higher than expected[1], this will move the deadline further into the next fiscal year. However, if tax revenues disappoint, the default could come earlier than expected.

Sequestration

The existence of a debt limit did not do much to slow down the accumulation of public debt. In fact, in terms of GDP, total public debt has risen from 30% in the 1980s to well over 100% in recent years. The Budget Control Act of 2011 made significant spending cuts over a ten year period and introduced spending limits[2], in addition to the debt limit. The Budget Control Act sets limits to the amount of discretionary federal spending in the fiscal years 2012-2021. If the appropriations bills passed by Congress exceed the spending caps for broadly defined categories for a certain fiscal year, the Treasury Department withholds the excess amount of funds from the government agencies that were supposed to benefit from the appropriated funds. The Treasury imposes automatic across-the-board spending cuts on the various categories. Sequestration aims to hit both defense and non-defense spending in a rather crude manner as it was originally intended to incentivize Republicans and Democrats to agree in early 2012 on a package of spending cuts for FY2012-2021. However, because negotiations failed, sequestration was triggered and now has to be dealt with every year.

Figure 2: Total public debt in terms of GDP
Figure 2: Total public debt in terms of GDPSource: Macrobond

The Bipartisan Budget Act of 2018 did not only suspend the debt limit; it also raised the spending caps imposed by the Budget Control Act of 2011 for FY2018 and FY2019. However, in FY2020 the spending cap is set to fall back again. If no agreement is reached on the budget for FY2020 before October 1, and Congress adopts a continuing resolution, automatic budget cuts will take place through sequestration. While sequestration is designed to hit defense and non-defense spending equally hard, the Republicans may be able to hedge the cuts in defense spending through the use of a Pentagon slush fund known as the 'Overseas Contingencies Operations' (OCO) fund. This would make the impact of sequestration asymmetric and give the Republicans leverage in the negotiations with the Democrats who would then be hit harder by the automatic spending cuts in case of no deal. If Congress even fails to adopt a continuing resolution, another government shutdown will take place in October.

Conclusion

The extraordinary measures available to the Treasury are expected to delay a government default to the turn of the fiscal year. This means that the debt limit may become entangled with the budget for the next fiscal year. Therefore a game of chicken between Democrats and Republicans may arise in September with the threat of a government default and either automatic spending cuts or a government shutdown.

Footnotes

[1] The CBO currently expects $3.515 trillion in tax revenues in FY2019 and $4.412 trillion in spending, leading to a budget deficit of $897 billion (Congressional Budget Office, The Budget and Economic Outlook: 2019 to 2029, Table 1-1).

[2] While the Budget Control Act of 2011 was aimed at slowing down federal spending, the Tax Cuts and Jobs Act of 2017 will reduce the tax revenues of the federal government. Consequently, total public debt is expected to rise further as % of GDP.

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Author(s)
Philip Marey
RaboResearch Global Economics & Markets Rabobank KEO
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