U.S. Debt Ceiling: Definition, History, Pros, Cons, and Clashes (2024)

What Is the Debt Ceiling?

The debt ceiling—also known as the debt limit—is the maximum amount of money that the United States can borrow cumulatively to meet its existing legal obligations. The debt ceiling was created under the Second Liberty Bond Act of 1917.

If U.S. government national debt levels bump up against the ceiling, then the Treasury Department must resort to other extraordinary measures to pay government obligations and expenditures until the ceiling is raised again.

The debt ceiling has been raised or suspended numerous times over the years to avoid the worst-case scenario: a default by the U.S. government on its debt.

Understanding the Debt Ceiling

Congress had free rein over the country’s finances before the debt ceiling was created. In 1917, the debt ceiling was created during World War I to make the federal government fiscally responsible.

Over time, the debt ceiling has been raised whenever the United States has approached the limit. By hitting the limit and failing to pay interest payments to bondholders, the United States would be in default, lowering its credit rating and increasing the cost of its debt.

There has been controversy over whether the debt ceiling is constitutional. According to the 14th Amendment of the Constitution, “The validity of the public debt of the United States, authorized by law...shall not be questioned.” The majority of democratic countries do not have a debt ceiling, making the United States one of the few exceptions.

Advantages and Disadvantages of the Debt Ceiling

Advantages

Having a debt ceiling in place is believed to be practical as it keeps the nation's finances in check. It allows the U.S. Treasury to easily issue bonds without having to get Congress's approval every time the federal government needs to raise money, which is a pretty cumbersome process. With a debt ceiling, the boundaries are in place for a more efficient monetary approval process.

Raising the debt ceiling allows the country additional wiggle room to keep funding federal operations. Put simply, it gives leaders the financial power to keep the government running.

A debt ceiling also provides the means to continue funding important social programs. In the United States, this means that the government can fund Social Security and Medicare, which are both essential to retirees and qualifying recipients.

Disadvantages

The debt ceiling is notoriously fluid, which means it can easily be raised. In fact, it has been raised a few times, raising questions on whether it’s effective as a tool to ensure fiscal responsibility. The U.S. has reached record-high levels of debt over time.

Increasing the debt ceiling has an inverse effect on the country's reputation in the global markets. As such, it may lead to a downgrade of the credit rating of the U.S. while increasing the overall cost of its debt.

Finally, some individuals believe that the debt ceiling is unconstitutional. Critics say the 14th Amendment requires the government to meet its financial obligations. Having a debt ceiling in place (and having to raise it) puts pressure on the country's ability to pay its bills.

Debt Ceiling Showdowns and Shutdowns

There have been many showdowns over the debt ceiling, some of which haveled to government shutdowns. The conflict is usually between the White House and Congress, and the debt ceiling is used as leverage to push budgetary agendas.

For example, in 1995, the Republican members of Congress, whose views were vocalized by then-House Speaker Newt Gingrich, used the threat of refusing to allow an increase inthe debt ceiling to negotiate increased government spending cuts.

Then-President Bill Clinton refused to make the cuts, which ledto a shutdown of the government. The White House and Congress eventually agreed on a balanced budget with modest spending cuts and tax increases.

Debt Ceiling During the Obama and Trump Administrations

President Barack Obama faced similar issuesduring his two terms as president. In the 2011 debt ceiling crisis, Republicansin Congress demanded deficit reductions to approve an increase in the debt ceiling. During this time, U.S. Treasury debt was stripped of its AAA rating by Standard & Poor’s—a rating it held for more than 70 years.

In 2013, the government was shut down for 16 days after conservative Republicans attempted to defundthe Affordable Care Act (ACA) by leveraging the debt ceiling. An agreement to suspend the debt limitwas passed within a day, which was when the Treasury was estimated to run out of money.

The debt ceiling was raised again in 2014, 2015, and early 2017. With U.S. debt exceeding $20 trillion for the first time in September 2017, then-President Donald Trump signed a bill extending the debt ceiling to Dec. 8, 2017. The ceiling was later suspended for 13 months as part of a bill enacted in February 2018. The ceiling came into effect and was increased again in March 2019 when U.S. government debt topped $22 trillion.

In August 2019, then-President Trump signed the Bipartisan Budget Act of 2019, which suspended the debt ceiling through July 31, 2021. The legislation also lifted spending caps on federal agency budgets, while ensuring that the government could pay its bills in the short term.

Suspending the ceiling in this manner eliminated the risk of default for another two years, increasing spending to $320 billion for the 2020 and 2021 fiscal years. The debt ceiling was once again raised, to $31.4 trillion, in December 2021.

2023 Debt Ceiling Crisis

In early 2023, some economists and Wall Street analysts predicted that the election of Californian Republican Kevin McCarthy to House Speaker raised the prospect that lawmakers could vote against lifting the debt ceiling, increasing the possibility of the U.S. defaulting on its debts.

As part of their support to install McCarthy, conservative-faction Republicans indicated that they would vote against raising the debt ceiling without significant federal spending reductions, setting the stage for political gridlock that could destabilize the financial system ahead of the new fiscal year that starts Oct. 1, 2023.

Yellen’s Warning to Congress

In mid-January 2023, Treasury Secretary Janet Yellen reiterated the importance of Congress raising the debt ceiling to avoid a potential default.

“Failure to meet the government’s obligations would cause irreparable harm to the U.S. economy, the livelihoods of all Americans, and global financial stability,” she wrote. “I respectfully urge Congress to act promptly to protect the full faith and credit of the United States.”

Debt Default Averted

Despite the ongoing political brinkmanship in Washington over the debt ceiling, most debt ceiling showdowns end with a last-minute compromise and spending cuts. President Biden successfully made deals with Republicans in 2021 to pass critical legislation, most notably the $1.2 trillion infrastructure package.

Another debt ceiling crisis began in 2023 when a newly elected Republican House majority signaled that it would leverage the debt ceiling for deep spending cuts. In January 2023, insights and market perspectives site AGF projected a 60% chance of Congress striking an 11th-hour deal to avoid a default, indicating the likelihood of macroeconomic uncertainty in the months ahead.

The U.S. officially hit the debt ceiling of $31.4 trillion on Dec. 30, 2022, and then it quickly came down the next day. It crossed the limit again on Jan. 17, 2023, and continued to stay above the limit. The Treasury was able to continue paying obligations through "extraordinary measures," such as redirecting payments from certain government-owned securities and pension plans. But these measures were projected to run out on June 5; After that, the Treasury would have to choose which obligations to prioritize.

The crisis was ultimately resolved in yet another last-minute agreement that suspended the debt limit till 2025, along with a cap on federal spending and restrictions on some poverty assistance programs. The deal was rushed through the House and Senate by June 1.

What Happens If the U.S. Defaults on Its Debts?

A default on government debt would send shock waves through global financial markets as confidence in U.S. borrowers falls. According to credit analysis firm Moody’s Analytics, a four-month default would:

• Shave around 4% of U.S. gross domestic product (GDP)
• See stock prices fall by a third
• Result in companies slashing nearly six million jobs

Furthermore, its analysis reveals that a default on U.S. Treasury bonds could lead to a downturn similar to the Great Recession.

A breakdown in the perceived trustworthiness of the U.S. Treasury or a credit freeze would almost certainly lead to sharp falls in the greenback and an exodus of U.S. investments by foreign investors. Even coming close to default has the potential to unnerve financial markets.

In 2011, then-President Obama and House Republicans narrowly averted reaching the debt ceiling, a crisis that saw stock prices plunge and volatility spike, prompting credit agency S&P Global Ratings to downgrade the U.S. credit rating for the first time. The crisis also dented consumer confidence and small-business optimism.

As well as creating economic uncertainty, a U.S. debt default would impede the government from carrying out critical functions, such as issuing Social Security benefits, maintaining national defense, and adequately funding the public health system.

The Bottom Line

The debt ceiling was created during World War I to regulate U.S. government spending and to keep the U.S. government fiscally responsible. Since then, the debt ceiling has been raised or revised 78 times to avoid the possibility of default and keep the U.S. economy running, with no signs of Congress turning to other options, despite questions over the debt ceiling’s effectiveness.