The Treasury Secretary Janet Yellen recently warned Congress about the threats of the debt ceiling not being raised. This was a bit hypocritical on her part because, as I will explain further in this blog, it’s partially her fault that we need to worry about the debt ceiling at all. Furthermore, she and the Democrats are overstating the risks of the debt ceiling not being raised. Of course, the wider point she makes is correct: the debt ceiling really must be raised.
In this blog I intend to explain the following things:
what the debt ceiling is and why it presents an issue;
how the Biden administration is making the problem worse;
why the Democrats more generally are making the problem worse;
The debt ceiling is overstated; and
The actual problems our country will face if the debt ceiling isn’t raised.
#1: What the Debt Ceiling is and Why it Presents an Issue
The debt ceiling is a legal limit on how much the Treasury Department can borrow. Money borrowed by the Treasury goes into the “Treasury General Account,” along with most federal tax revenue. The Treasury general account pays for most federal spending, including payments on existing federal debt.
Some federal taxes and spending does not directly involve the Treasury general account. For example, Social Security, Disability Insurance and Medicare Part A are paid for with funds from separate accounts, or trust funds. These trust funds get most of their money from payroll taxes which do not go to the Treasury general account.
Because the debt ceiling effectively limits the Treasury’s ability to borrow, it limits the amount of money that can go into the Treasury General Account. When that limit causes the money in the account to fall to 0, in theory the Treasury has to stop paying for some things.
I’ll call this hypothetical event, which has never happened, a “debt ceiling crisis.”
Debt ceiling crises are different from government shutdowns, which occur when the government does not pass a law authorizing the Treasury to pay for government expenditures. For the government to work when the Treasury General Account is running a deficit, Congress needs to both give the Treasury permission to increase its debt and give the Treasury permission to pay for government programs.
A debt ceiling crisis would create a headache for the Treasury. Legally, the Treasury cannot borrow more money or take more money in through higher taxes without Congress giving permission. Additionally, Congress has already passed a law specifying that it appropriate specific amounts of money to existing government programs. Furthermore, through contracts, the Treasury is legally obligated to fully pay all obligations on government debt.
The closest the government ever came to a debt ceiling crisis was in 2013. At that time, the Treasury department engaged in what it termed “extraordinary measures” to keep paying for everything. The Treasury Secretary at the time, Timothy Geitner, wrote a letter explaining these measures, which included temporary freezes in contributions to federal employee pension funds and contributions to a fund set up to manage foreign exchange rates. Furthermore, Geithner decided to temporarily stop lending money to states under a specific program. Finally he mentioned that the Treasury may sell some of its remaining gold reserves.
Most of these measures were accounting tricks: the Treasury delayed some payments and loans by about a week and those payments/loans would send money to an account which would then invest money in Treasury debt. Essentially the crisis stopped the Treasury from lending to another part of the government which then had less money to lend back to the Treasury.
Currently, the debt ceiling does not exist. But, under current law at the end of the day on July 31st the debt ceiling will start existing again and will be set equal to the level of debt at the time it starts existing. As a result, the Treasury will not be able to borrow any more money. It will be a matter of time, even with legal extraordinary measures taken, when the Treasury General Account runs out of money and the Treasury has to stop paying for some things that it legally should.
Even if there isn’t, the Biden Treasury Secretary, Janet Yellen perhaps should issue more debt right now. This would push up interests up slightly and somewhat slow the economy. However, it would remove the ammunition for Republicans to threaten to not increase the debt ceiling. Furthermore, if interest rates go high enough, at some point the FED will have to create more money to buy Treasury debt.
#2: Why It’s Kind of the Fault of the Democrats:
The debt issue is made worse by Treasury Secretary Janet Yellen’s decision to gradually reduce the money in the Treasury general account right now even though there is no legal limit on her ability to borrow. The chart below shows the development of the money in the Treasury general account over the past 5 years. It shows that during the crisis, the Treasury increased the size of its account by over 1 trillion dollars. However, around the time Joe Biden was inaugurated the Treasury decided to roll back the size of its general account to a more normal level.
There isn’t really a correct level for the General Account to be at. In theory, the Treasury could issue a lot of debt and the Federal Reserve (FED) could buy a lot of Treasury debt. Then the Treasury could hold onto the money it raised and put it into the General Account which is stored at the FED. So the FED could easily lend the Treasury a lot of money and the Treasury could lend that money back to the FED. This wouldn’t do anything except as far as accounting goes, the Treasury will now have spare money to spend when the debt ceiling comes back.
So, the Democrats who run the government have decided to make sure that there is less money in their account by the time they are no longer allowed to borrow. The most important impact of this decision is that it gives the Republicans more leverage after July 31st in any debt ceiling related negotiations.
#3: Why the Democrats are Making the Problem Worse
A debt ceiling crisis will be a great opportunity for moderate Democrats to politically justify a move to austerity. In 2011, Obama used a potential debt ceiling crisis as an attempt to make major cuts to America’s welfare spending and social safety nets, including Social Security. Democratic presidents can’t usually adopt Republican political positions and bring the rest of the party with them under normal circumstances. What they try to do is create a bargain which gives Democrats a way to explain their decisions to the electorate. If a Democrat votes to cut Social Security normally, he will face serious primary challenges and alienate key constituencies in the next general election. If the leader of his party meets with the leader of the Republicans and hashes out a deal, then he has an excuse. This is especially true if a deal needs to be stuck to raise the debt ceiling in order to save the global economy.
#4: The Debt Ceiling is Overstated
Perhaps the most often repeated concern about the debt ceiling is that when the Treasury can no longer borrow it can no longer borrow enough money to pay interest on the money it has already borrowed. Janet Yellen raised this concern recently when she warned Congress about the threats of not raising the debt ceiling. She said, “I would plead with Congress simply to protect the full faith and credit of the United States by acting to raise or suspend the debt limit as soon as possible.” Of course, I’ve already gone into her hypocrisy on the matter.
urthermore, some people are worried about how the debt ceiling could impact the trust funds for Social Security, Disability Insurance and Medicare Part A. The concern is that if the debt ceiling makes the Treasury default on its debt and stop paying IRS officials to process payroll taxes, those trust funds will run out of money as they have no income and all their wealth is in US government debt.
Those fears are unfounded. Obviously, if the Treasury is unable to borrow money, the last program it would cut would be the IRS. Furthermore, Janet Yellen certainly wouldn’t risk a debt ceiling crisis by lowering the Treasury General Account if she thought the government actually would default on its debts. Furthermore, the government basically always has more tax revenue coming into its General Account than is necessary to pay for the IRS or interest on the debt. Monthly data from the Treasury website, plotted below shows that total income receipts to the General Account (on-budget income) always outweigh Treasury Department expenditures, which include IRS enforcement and interest payments (as well as net Federal Reserve operating costs which are often negative).
In reality, the threat that the Republicans would force a default or impact Social Security by not raising the debt ceiling is a myth contrived by the Democrats to justify a future deal with the Republicans.
#5: The Actual Problems Our Country Will Face if the Debt Ceiling Isn’t Raised
If the debt ceiling is not raised in time, some programs will be cut. Enhanced unemployment benefits, a program slated to end shortly after when it seems the debt ceiling will become effective, will be the first program to be non-funded. Discretionary non-defense spending and even some defense spending used for medical research will probably be cut next. This will harm economic development in the long term.
The poorest Americans will likely suffer the most when the cuts become more severe. Medicaid and food stamps will likely be the focus of the next round of cuts.