The Debt Ceiling and Deficit Spending

On January 19, 2023, the outstanding debt of the U.S. government reached its statutory limit, commonly called the debt ceiling. The current limit was set by Congress at about $31.4 trillion in December 2021.

On the day the limit was reached, Treasury Secretary Janet Yellen instituted well-established “extraordinary measures” to allow necessary borrowing for a limited period of time. While Yellen projects the extension will last until early June, the Congressional Budget Office (CBO) estimates it may last until sometime between July and September. However, the CBO cautions that if April tax revenues fall short of its projections, the Treasury could run out of funds earlier.

Flexibility vs. Fiscal Fights

The debt ceiling was first established in 1917 to give the federal government more flexibility to borrow during World War I. Before then, all borrowing required specific Congressional authorization, which made responding to changing financial needs difficult.

The modern debt ceiling, which covers nearly all government debt under a single limit, was created in 1939. Since 1960, it has been raised, modified, or suspended 78 times, usually without controversy. That changed in 2011, when a political battle over the ceiling pushed the Treasury close to the limit, prompting Standard & Poor’s to downgrade the U.S. credit rating.

The debt ceiling limits how much the Treasury can borrow to meet financial obligations already authorized by Congress. It does not approve new spending. However, since 2011, the ceiling has often been used as leverage in partisan negotiations over government spending. With the White House and the House of Representatives controlled by different parties, this year’s negotiations could be particularly challenging.

Potential Consequences

If the debt ceiling is not raised in a timely manner, the U.S. government could default on its financial obligations, resulting in unpaid bills, higher interest rates, and a loss of faith in U.S. government securities that would reverberate throughout the global economy. While it’s unlikely that the current situation will lead to a default, pushing negotiations close to the edge can be damaging in itself. It was estimated that the 2011 impasse cost U.S. taxpayers $1.3 billion in increased borrowing costs in FY 2011 with additional costs in the following years.

The Deficit and the Debt

Put simply, the federal government runs a budget deficit when tax revenues are not enough to cover spending. Federal spending has exceeded revenue for the past 50 years, with the exception of 1998 to 2001.

Annual budget deficits add to the national debt. At $31.4 trillion, the current debt is the highest in U.S. history. However, economists often measure debt as a percentage of gross domestic product (GDP), which allows for better comparisons over time.

Economists focus primarily on debt held by the public. This includes money the government borrows to fund operations and meet obligations, mainly by issuing Treasury securities. Interagency debt, such as funds borrowed from Social Security trust funds, is also subject to the debt limit. However, it does not directly affect the economy or the federal budget.

At the end of fiscal year 2022 (September 30, 2022), debt held by the public equaled 97% of GDP. By comparison, it was 79% of GDP in 2019, before the pandemic, and 35% in 2007, before the Great Recession. Both crises sharply increased deficits and debt due to falling tax revenues and large government stimulus programs. The last time debt exceeded today’s level was at the end of World War II.

In a February 2023 analysis, the Congressional Budget Office (CBO) projected that debt will continue to rise over the next decade, reaching 118% of GDP by 2033—the highest level in U.S. history. The main drivers are higher spending on Social Security and Medicare and rising interest costs due to increased borrowing and higher interest rates. If current laws remain unchanged, the debt is expected to grow even faster in the following decades, reaching 195% of GDP by 2053.

No Easy Answer

The only way to change this trajectory is to increase revenue, reduce spending, or do both. The most optimistic scenario would be decades of strong GDP growth that boosts revenue without raising taxes. However, this appears unlikely. The Congressional Budget Office (CBO) projects that real, inflation-adjusted GDP growth will average only 1.7% per year over the next decade.

Raising tax rates may be necessary, but it is a politically difficult option. There is also limited flexibility on the spending side. Only 28% of federal spending is discretionary, meaning Congress can adjust it through annual appropriations. Nearly half of that discretionary spending goes to national defense, an area few policymakers are willing to cut given current global conditions.

The remaining spending is mandatory, including Social Security and Medicare, which are expected to account for nearly 36% of federal spending in 2023, along with interest on the national debt. While both political parties have said Social Security and Medicare are off the table, other mandatory programs could still be reduced through Congressional action.

The White House is expected to release its FY 2024 budget proposal in March, followed by a House Republican counterproposal in April. This sets the stage for an intense period of budget negotiations. President Biden and House Speaker Kevin McCarthy have already begun discussing the debt ceiling. It remains unclear whether the issue will be resolved outside the budget process or become part of it. Regardless, the debt ceiling will need to be raised or suspended to maintain government operations.

Important note on U.S. Treasury securities:

• Treasuries are guaranteed by the federal government for the timely payment of principal and interest.
• Their principal value fluctuates with market conditions.
• If not held to maturity, they may be worth more or less than the original amount paid.

Forecasts are based on current conditions, may change, and may not come to pass.

IMPORTANT DISCLOSURES

Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, legal, or retirement advice or recommendations. The information presented here is not specific to any individual’s personal circumstances.

To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.

These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.

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