(Bloomberg) -- Months before many officials in Washington — and investors in the bond market — anticipated, the federal debt ceiling has re-entered political discourse, after President-elect Donald Trump said Dec. 19 that he’d back getting rid of the cap entirely, more than a century after its creation. The limit has long been a tool of political leverage for the party in opposition, because of the dire consequences of any failure to either suspend or increase it.
What is the debt ceiling?
It’s a cap on US government borrowing, first established by Congress in 1917. Because lawmakers keep enacting bills to spend more money than the government takes in, the Treasury must keep borrowing more, pushing up the debt. That requires addressing the debt ceiling or risking default. The last action taken was in June 2023, when lawmakers suspended the ceiling until the start of 2025.
What happens when the ceiling kicks back in?
From Jan. 2, the Treasury will no longer be able to boost the amount of debt that would be subject to the limit, which as of Dec. 18 stood at more than $36 trillion. Because the federal government will continue to spend more than it receives, the department will then need to run down its stockpile of cash in order to keep making good on obligations, including payments to government bondholders, retirees and veterans. As of Dec. 17, that cash balance was about $831 billion. That may be sufficient to keep the Treasury going for months. In March, it’s set to receive a big influx of cash from individual tax payments, which are due in mid-April.
In the meantime, the Treasury will deploy so-called extraordinary measures — essentially accounting gimmicks, which have been used repeatedly over the decades — to make sure its cash buffer doesn’t completely run out. These measures include suspending the reinvestment of Treasury securities held by various government funds, including retirement funds for government employees. Those accounts are then made whole later, once the debt limit is set aside or increased.
But the measures can only last until a so-called X-date, the point at which the Treasury is no longer able to meet all its obligations. Bond market strategists have anticipated that moment would probably arrive between mid- to late-2025. Treasury secretaries have typically refrained from spelling out exactly what the department would do in the worst-case scenario of Congress failing to raise or suspend the debt ceiling before then.
Why does Trump want to get rid of the ceiling?
The debt ceiling is a headache for every administration that faces it. In Trump’s first term, the need to boost the limit or set it aside gave Democrats leverage to negotiate for more spending in budget deals with the Republican president. Trump’s top fiscal priority next year will be renewing personal income tax cuts that he enacted in 2017 that are set to expire at the end of 2025. The nonpartisan Congressional Budget Office (CBO) has cautioned that a full extension would add trillions of dollars to government borrowing needs over the coming decade — necessitating a bigger and bigger debt pile. The need to address the ceiling could complicate negotiations over securing congressional approval of the tax-cut extensions.
Would Congress agree to eliminate the debt ceiling?
Predicting what legislators will do is a hazardous undertaking. A swath of Republicans traditionally have been unwilling to vote for raising the debt ceiling, which they view as incompatible with reining in the budget deficit. Trump did win immediate backing for his idea from an otherwise unlikely supporter: progressive Democratic Senator Elizabeth Warren, who said Dec. 19 in a post on X that the debt limit amounted to political “hostage taking.”
One senior Democrat in the House of Representatives, Brendan Boyle, previously proposed legislation that would empower the Treasury secretary to unilaterally boost the ceiling, while reserving for Congress the power to nix that move through a vote. Outgoing Treasury Secretary Janet Yellen said in a 2022 hearing that she “strongly” supported that kind of proposal. “It is simply insanity to face debt ceiling crises periodically,” she said.
What would be the consequences of getting rid of the debt ceiling?
Aside from a massive wave of relief among the staff at the Treasury’s Office of Domestic Finance, eliminating the limit would avert the major disruptions to the bond market that occur every time the ceiling becomes an issue. US debt managers slash the issuance of Treasury bills when the limit is reached, starving money market funds and other investors of a chunk of the securities that they depend on to park their own cash in. When the limit is hoisted or set aside, the market then has to absorb a tidal wave of bills as the Treasury rebuilds its cash balance.
Debt-limit showdowns in the past have also involved warnings from credit-rating agencies, which have viewed the episodes as damaging for the fiscal credibility of the US. Fitch Ratings put the country under review during the last battle over the limit, and ended up cutting the rating by one step, to AA+, even after the ceiling was set aside.
What’s the worst that could happen if the ceiling is breached?
Failure to act before the Treasury runs out of space to keep making good on its payments would leave the secretary of the department — Trump has nominated Scott Bessent for the job — the dire task of deciding whether to prioritize some obligations over others. One widespread assumption among economists and bond market participants is that the department would use the cash and revenue it does have to ensure that payments were made on Treasury securities. That assumption relies in part on transcripts from emergency Federal Reserve conference calls in 2011 and 2013 during past debt-limit standoffs.
Because Treasuries are the world’s largest bond market and a benchmark for borrowing costs worldwide, failing to service them would pose a shock that could trigger a financial meltdown — a risk officials wouldn’t want to take. Assuming that the Treasury did keep making payments on debt securities, the government would next need to decide whether to keep paying the vast amount of its other obligations including Social Security payments, federal salaries and the costs of running government agencies.
What’s the broader fiscal backdrop?
US government finances are looking more challenging than ever before. The 2024 budget deficit was at its highest since the Covid pandemic years — the shortfall came to $1.83 trillion, or 6.4% of gross domestic product (GDP). The outgoing Biden administration has forecast that in 2025, for the third straight year, the deficit will be in excess of 6%.
Looking further into the future, the CBO has projected that the deficit would average roughly 6% of GDP over the coming decade. However, that estimate assumes tax rates will rise in 2026 after the expiration of much of Trump’s 2017 tax-cut package, which Trump wants to extend and expand.
There’s not a single factor driving the widening gap. Congress and the White House for years have failed to heed warnings from budget experts urging spending restraint, instead enacting spending and tax packages that added to government red ink. Emergency programs to combat the Covid pandemic, along with steady growth in health-care and retirement-benefit spending and, crucially, rising interest costs piled onto the debt burden.
What happens next?
It will be up to congressional leaders to either consider legislation on the debt ceiling or put that off for a time as the Treasury starts running down its cash and engaging in the extraordinary measures. In the meantime, Yellen is expected to write to Congress over the coming days or weeks to give lawmakers a general estimate from the Treasury on when the debt limit may become binding. She’s unlikely to offer a precise date, given that tax receipts and other financial inflows and outflows can vary, but she will likely point to a month or point in time after which it is much less certain that the US will be able to meet its obligations.
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