Debt limit: What’s the deal and who’s going to blink?

Timeline: Countdown to the X-Date

In 1939, Congress established an aggregate public debt limit for all outstanding securities. While the lifting of the debt limit generally has been a routine exercise throughout history, in the last decade it has become a leverage point (at times) used by some in Congress to address budget reform measures.?In theory the debt limit could be lowered, but in practice it only moves in one direction – up.

The US met its statutory debt limit of $31.38 trillion on Jan. 19, 2023. At that time, the Treasury Department began implementing accounting measures to allow the government to continue to operate for a limited period, until reaching the “X-Date.” That’s when the US will be unable to meet all its obligations in full and on time. While the exact X-Date is unknown – because there are several revenue factors that could alter the timeline – it is likely to be early to late summer.

Early expert predictions are that the “X-Date” will arrive sooner due to the expectation that federal tax receipts will be lower than previous years and in particular fiscal year 2021 numbers. This is based in part on a slowing economy in comparison to 2021 that saw a stable stock market, economic growth, and very strong capital gains tax receipts. The delta in terms of tax revenue will impact federal government cash flows, thereby impacting when the government will hit that “X-Date” – or more bluntly put, not be able to pay its bills.

The Treasury Department is expected to have an analysis of tax receipts within the next few weeks and could allow for greater clarity, while another milestone impacting the “X-Date” will be the estimated tax?payments that are due June 15. If the country arrives on June 15 with strong receipts, it will allow for more time for Congress to negotiate a deal.?

Historical debt outstanding: 1992-2022

The unstable House

Since its establishment, the debt ceiling has been raised or suspended more than 90 times. With that success, the United States has never defaulted on its obligations. This well-established history of successful debt ceiling increases has been put to the test in the past 10-15 years, however, as the political parties seek to maximize any potential or perceived leverage. What was formerly seen as a perfunctory exercise has become an existential moment of truth, with brinksmanship that resulted in the first-ever downgrade of the credit rating of the United States back in 2011.(1)

In the last Congress, then Minority Leader McCarthy indicated he would use the debt limit to force spending cuts. During the prolonged process of gaining enough support to become Speaker, McCarthy struck a deal with the conservative Republicans of the Freedom Caucus to take it a step further and explicitly link a debt limit increase with a budget agreement.

After a short trip to Wall Street and a promise to answer the call for action, on April 19, Speaker McCarthy and his House GOP unveiled a plan entitled the Limit, Save, Grow Act (LSG), which would increase the nation’s debt ceiling limit by $1.5 trillion coupled with an estimated $4.5 trillion in spending cuts. ?The proposal comes with a long list of cuts that include returning funding for federal agencies to fiscal 2022 levels (excluding the DOD); blocking student loan forgiveness; rescinding new IRS funding; adding work requirements to safety net programs; repealing green energy tax credits from the Inflation Reduction Act (IRA); rescinding unobligated COVID-19 funds, and includes House Republicans signature energy bill H.R.1, The Lower Energy Costs Savings Act.?

Democrats have not been shy about pointing out their perceived negative societal ramifications of the the LSG. House Appropriations Ranking Member Rosa DeLauro (D-CT) put forward a four-page press release on the federal cuts that would impact schools, childcare, police and local emergency services, and border security, as well as harm senior citizens' cost of living, just to name a few criticisms. House and Senate Democrats continue to align with the White House position in that they have claimed an openness to negotiate federal spending cuts but not in the context of a debt ceiling package deal; instead they would like those discussions orchestrated under traditional budget and appropriations discussions.

Nevertheless, should McCarthy be able to pass his debt ceiling package on the House floor, the ball is in the Senate’s court and the pressure on the White House to sit down to negotiate will continue to mount. Recent press reports have indicated that a House-passed proposal may be the opening salvo that will bring the Administration and the Speaker to the negotiating table.

The wait-and-see Senate

Currently, there is no political appetite for a clean debt limit increase without budget reforms for Senate Republicans, so any effort to advance one will likely be met with a filibuster. Even though Senate Minority Leader Mitch McConnell (R-Kentucky) has a much more secure leadership post within his conference, he has made it clear that he is intent on waiting to see what McCarthy and House Republicans can come up with before inserting himself in the conversation. However, there will ultimately be outside pressure for him to work with Democrats to come to agreement and avoid a default.

Moderate Democrats like Senator Joe Manchin (D-West Virginia) and Kirsten Sinema (I-Arizona) have signaled they are open to the discussion about budget reforms, with Senator Manchin in recent days expressly commending Speaker McCarthy for “putting forward a proposal that would prevent default and rein in federal spending.” Both Senators are up for reelection in 2024, adding increased political calculations and drama on navigating an incredibly dicey policy conundrum. It’s in these conversations that cuts to entitlements – like Medicare – are absolutely off the table, but some believe Democrats could be open to other budget reforms in the hopes of finding a bipartisan solution that avoids a fiscal crisis.

What if we reach the X-Date?

If Congress fails to act and does not raise the debt limit by the X-Date, there are a few possible courses the Biden Administration can take – none of which will be publicly entertained until all other efforts have been exhausted.?

The first would be the prioritization of payments, such as making principal and interest payments on Treasury securities while delaying payments such as Social Security benefits, tax refunds and military salaries. Not only are the logistics of this kind of prioritization daunting, but likely Herculean given that officials will only have a few weeks’ warning to implement. A Senate Republican bill has been proposed that would prioritize debt payments, Social Security and other obligations should Congress fail to raise the ceiling, and there are reports of a House Republican bill that would also likely include the prioritization of debt payments.

The second course of action could have Treasury pay all of its obligations as cash becomes available, which is the path the department has previously said would be the least harmful. This would establish a delayed payment system, but because the US operates at a deficit, payment delays would worsen each day the debt limit remains unchanged. This option would avoid the debate over prioritization of payments that would likely become highly political, as referenced above.

Finally, the Biden Administration could consider a series of executive actions that would serve as short-term solutions but could also destabilize markets and are deemed impractical by current Treasury officials. Those measures could include:

• An interpretation of the 14th Amendment that would deem the debt limit unconstitutional.
• The creation of a trillion-dollar coin that would be deposited at the Federal Reserve and used to pay existing bills.
• The issuance of super premium treasuries that would allow the Treasury the opportunity to legally issue a lot of debt and keep the government running (a strategy that was unsuccessfully used in Greece).
• A “fire sale” of assets such as buildings, gold or mortgage-backed securities.
• The issuing of IOUs to instead of paying bills in cash.?

Summary

With a White House currently unwilling to negotiate on budget reforms, the internal Republican conference pressure on Speaker McCarthy, and a Senate unwilling to default but not yet ready to engage, this debt ceiling fight promises to be the most contentious yet.

1 Source: BBC, “US loses AAA credit rating after S&P downgrade,” Aug. 6, 2011

Important information

NA2782127

Header image: Toche_O / Getty

The opinions referenced above are those of the author as of April 23, 2023. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.