A History of the U.S. "Debt Ceiling"

   By Nízida Arriaga, CFA
   Manager, Fixed Income
 
   January 10, 2022

The U.S. government found itself in another debate regarding the debt ceiling this month, as members of both chambers of Congress once again worked to raise its borrowing limit and avoid a government shutdown. Though the ceiling was eventually raised, averting a shutdown, the renewed debate sparks an interesting conversation about the purpose of the debt limit and why it exists in the first place.

Let's start with the basics. The U.S. government has a budgetary deficit; it spends more money than it generates in a given year. This means it must borrow to pay the difference. The U.S. Treasury is the agency that borrows on behalf of the government, and the debt ceiling, or debt limit, is essentially the maximum debt that the Treasury is allowed to incur.

The debt ceiling is not about approving new expenditures; it is about paying for expenditures that have already been approved by Congress. This includes spending to fund Social Security payments, Medicare benefits, military and federal government employee salaries, interest on the existing national debt, and tax refunds. It is important that the government makes these payments because defaulting negatively impacts beneficiaries and public employees. Defaulting also adversely affects the U.S. government's debt rating—which would have dramatic consequences for the U.S. economy.

I think there's a natural question to address here: If the spending that creates the budget deficit and requires increased borrowing has already been approved, why is there a frequent need to raise the debt ceiling? To answer this, let's have a very brief civics lesson!

Article I, Section 8 of the U.S. Constitution describes the powers of Congress. One of these powers, often referred to as the "power of the purse," grants Congress the right to set expenditures, national budgets and debt issuance.

The Constitution itself does not establish a debt ceiling or limit. Rather, the precursor to the modern debt limit dates back to 1917 and the passage of the Second Liberty Bond Act.¹ Things were a bit different in those days. In fact, in 1916, one year prior to the Second Liberty Bond Act, the U.S. had very little debt—less than 3% of gross domestic product.²

At the time, Congress was required to approve every bond issuance. This became logistically impractical as spending increased during World War I. The solution was to create a debt limit, which gave the U.S. Treasury flexibility to manage borrowing without requiring approval from Congress; laws in 1939 and 1941 would later establish limits on all federal spending.³

In 1974, Congress enacted the Congressional Budget and Impoundment Control Act (ICA), establishing the House and Senate Budget Committees, the Congressional Budget Office, and new procedures by which Congress would review and authorize annual budgets. Though the ICA made budget setting a closely monitored yearly process, raising the debt ceiling was a separate consideration. In other words, Congress could approve both a budget and any new borrowing required to pay for it, but if that borrowing brought the national debt above the debt ceiling, it would have to approve another law to raise the ceiling.⁴

In 1979, Missouri Rep. Dick Gephardt offered a simple solution—Congressional approval of a budget should also be considered approval for whatever borrowings and/or increased debt limits it required.⁵ The Gephardt Rule, as it was known, was in place until 1995, when it was suspended by Congress.

Since 1995, the United States has seen several debt ceiling crises—including two government shutdowns in that first year without the Gephardt Rule. In 2011, the threat of the U.S. government defaulting on its debt, which was caused by a similar debt ceiling debate, rattled the markets and caused rating agency Standard and Poor's to downgrade U.S. government debt to AA+ from AAA.

Many have argued that the current approach to managing the debt ceiling is unnecessary and that a solution similar to the Gephardt Rule should be reinstated. For instance, Janet Yellen, the current U.S. Treasury Secretary, has said, "I believe when Congress legislates expenditures and puts in place tax policy that determines taxes, those are the crucial decisions Congress is making. And if to finance those spending and tax decisions it is necessary to issue additional debt, I believe it is very destructive to put the President and myself, as Treasury Secretary, in a situation where we might be unable to pay the bills that result from those past decisions."⁶

Yellen and other critics of the debt ceiling may be supported by precedent in other countries. Denmark is the only other major Western country with a debt ceiling, and its limit is much higher relative to its spending than in the U.S. The closest Denmark has been to its debt ceiling was in 2010, when spending reached 75% of the limit.¹ The ceiling was increased by more than double afterward.

¹ https://www.cfr.org/in-brief/whats-stake-debt-ceiling-showdown

² https://www.theatlantic.com/business/archive/2012/11/the-long-story-of-us-debt-from-1790-to-2011-in-1-little-chart/265185/

³ https://www.wsj.com/articles/debt-ceiling-reconciliation-partisan-budget-negotiations-spending-federal-deficit-11629753688

⁴ Ibid.

⁵ Ibid.

⁶ https://www.nytimes.com/2021/09/27/us/politics/us-debt-ceiling.html