United States: Government Shutdown And Hitting The Debt Limit: A Primer On What It All Means

Last Updated: October 15 2013
Article by Stephanie A. Kennan and Brian J. Looser

With Washington entangled in debate over the government shutdown, and the U.S. Treasury warning that the government has hit its debt ceiling limit, the difficulties facing policymakers and what is at stake may be unprecedented. To assist in understanding the discussion, we have prepared this explanation of the basics.

The continuing resolution and the debt ceiling are two different concepts designed to address two different situations. A government shutdown occurs because there is no authority to obligate funds. By contrast, in a situation in which the debt limit is reached and Treasury exhausts its financing alternatives, aside from ongoing cash flow, an agency may continue to obligate funds. However, Treasury cannot borrow to meet federal outlays due to a shortage of cash.

Continuing Resolution (CR)

Congress must provide legislation to authorize budget authority for most federal agencies and programs on an annual basis. This is usually done through the passage of appropriations bills. However, should the fiscal year begin without the annual appropriations bills having been enacted, Congress must resort to a stopgap spending measure known as a continuing resolution (CR) to keep federal agencies operational while longer-term legislation can be considered. A "clean CR" refers to such a stopgap measure that largely maintains current spending levels. A CR, however, can change the spending levels of the federal programs it funds.

This year, as fiscal year (FY) 2014 began on Oct. 1, no appropriation bill has been passed for any part of the government. Thus, a CR was needed to fund the functions of the government. Without a CR to provide authority for federal agencies to make financial obligations, the government shut down.

Mandatory vs. Discretionary Funding

Some programs are considered "mandatory" spending. Unlike the national parks and the National Institutes of Health, which are "discretionary" spending, mandatory spending programs continue even if the government has to shut down.

Medicare

In the short term, the Medicare program, because the benefits that it pays beneficiaries constitute mandatory spending, will continue largely without disruption, despite the current lapse in appropriations. Additionally, other nondiscretionary activities including Health Care Fraud and Abuse Control (HCFAC), Center for Medicare & Medicaid Innovation (CMMI) and Pre-Existing Condition Insurance Plan (PCIP) activities would continue. However, CMS would be unable to continue discretionary funding for healthcare fraud and abuse strike force teams, resulting in the cessation of their operations. Because a potential consequence of a government shutdown includes fewer recertification and initial surveys for Medicare and Medicaid providers being completed, beneficiaries would be put at risk of a lower quality of care. In addition, the longer the government is shut down, there is a likelihood of of a longer lag time in how fast claims are processed for payment.

Medicaid

States will have funding for Medicaid on Oct. 1 despite the absence of FY 2014 appropriations due to the advanced appropriation enacted in the FY 2013 appropriations legislation. This is true as well for the Children's Health Insurance Program (CHIP). CMS's Medicaid activities related to implementation of large portions of the Affordable Care Act (ACA) will also continue, including coordination between Medicaid and health insurance marketplaces.

Debt Ceiling

Under normal circumstances, partly due to its ability to borrow funds, the Treasury has sufficient financial resources to pay all obligations arising from discretionary and mandatory spending, including interest payments on the debt. However, on Sept. 25, 2013, Treasury Secretary Lew notified Congress that the government would exhaust its borrowing capacity around Oct. 17. At that point, the U.S. Treasury would have a cash balance of only $30 billion to meet federal obligations.

Beginning in 1789 and for approximately 130 years thereafter, Congress generally had to act each and every time Treasury needed to borrow money. Since World War 1, however, Congress has provided Treasury with increasing flexibility to manage the federal debt. In more recent times, Congress has set a debt limit — an amount that Treasury can borrow up to but not over without congressional action. That is the debt ceiling. The current debt limit is $16.699 trillion. Treasury cannot borrow more unless Congress votes to raise the ceiling.

In the past, Treasury Secretaries when faced with a nearly binding debt ceiling have used special strategies to handle cash and debt management responsibilities. Since 1985 these "extraordinary measures" have included:

  • Suspending sales of nonmarketable debt (savings bonds, state and local series, and other nonmarketable debt);
  • Trimming or delaying auctions of marketable securities;
  • Underinvesting or disinvesting certain government funds (Social Security, Government Securities Investment Fund of the Federal Thrift Savings Plan, the Civil Service Retirement and Disability Trust Fund, Postal Service Retiree Health Benefits Fund and Exchange Stabilization Fund); and
  • Exchanging Treasury securities for non-Treasury securities held by the Federal Financing Bank (FFB).

The government technically reached its borrowing limit on May 19, but won't actually run out of cash to pay its bills until sometime after Oct. 17. Since May 19, using "extraordinary measures," the government has raised an extra $303 billion to ensure the government can meet all its obligations.

According to the Treasury Secretary, the $30 billion that the Treasury would have on hand on Oct. 17,"would be far short of net expenditures on certain days which can be as high as $60 billion."

Defaulting

According to the Bipartisan Policy Center, on Oct. 17 the government will have only enough tax revenue to cover 68 percent of its obligations for the month. Thus, the first default may not happen exactly on Oct. 17, but rather when a bill comes due that exceeds the Treasury's cash on hand. Particularly ominous dates include:

Oct. 23: The government will owe $12 billion in Social Security payments.

Oct. 30: The government will owe $2 billion in Medicaid payments.

Oct. 31: The government will owe $6 billion in interest on its debt.

Nov. 1: The government will owe $58 billion in Social Security payments, disability benefits, Medicare payments, military pay and retiree pay.

So what will happen? One scenario is that the government's computers keep printing checks and some would bounce, unless a debt ceiling increase limit has been passed. At the very least, the government would not be able to pay all debts on time.

Medicare, Social Security and Debt Ceiling

If Treasury delays investing a federal trust fund's revenues in government securities, or redeems prematurely a federal trust fund's holdings of government securities, the result would be a loss of interest to the specific trust fund. This could worsen the financial situation of the affected trust fund(s) and accelerate insolvency dates. Congress passed PL 104-121 to prevent federal officials from using the Social Security and Medicare trust funds for debt management purposes except when necessary to provide the payment of benefits and administrative expenses of the program.

The Social Security and Medicare trust funds were created to account for monies that are dedicated to those programs. The fund accounts maintained by the Department of the Treasury provide a mechanism for keeping track of all program income and disbursements. Accumulated assets of the funds represent automatic authority to pay program benefits (that is, no annual legislation is needed to spend a portion of trust fund assets on these costs). If the trust funds were exhausted, congressional action would be needed to pay benefits not covered by current program revenues.

While the trust funds are treated separately under budget rules, what is important to understand is the flow of funds between general revenue and the respective trust funds. The Medicare program has two trust funds: the Hospital Insurance (HI) and the Supplementary Medical Insurance (SMI) Trust Funds. The HI trust fund is financed primarily by payroll contributions. Other income includes a small amount of premium revenue from voluntary enrollees, a portion of the federal income taxes beneficiaries pay on Social Security benefits and interest credited on the U.S. Treasury securities held in the HI trust fund. Parts B and D of SMI are financed by transfers from the general fund of the Treasury. Beneficiaries pay 25 percent of the Part B costs in the form of monthly premiums.

When a trust fund invests in U.S. Treasury securities, it has loaned money to the rest of the government. The value of the securities held is recorded in the budget as "debt held by government accounts" and represents debt owed by one part of the government to another. The securities constitute a liability for the Treasury because the loan must be repaid when the trust fund needs to redeem securities in order to make benefit payments. As with marketable bonds, these Treasury securities are backed by the full faith and credit of the U.S. government.

A rough analogy would be to think of the general fund as a checking account from which purchases of all sorts can be made, while the trust funds represent retirement savings accounts with specific rules for withdrawals. For example, the SMI trust fund receives large transfers from the general fund, the size of which depends upon how much the program spends, as opposed to how much revenue comes into the Treasury. If non-dedicated revenues become insufficient to cover both the mandated transfer to SMI and expenditures on general government programs, Treasury must borrow to make up the difference. In the long run, if there is insufficient funding, to meet obligations, and Treasury cannot borrow to make up the difference, Congress must allow Treasury to borrow, raise taxes, cut other government spending or reduce spending on the benefits.

Could the Treasury Prioritize the Bills They Pay?

Some have argued that prioritization of payments can be used by Treasury to avoid a default on federal obligations by paying interest on outstanding debt before other obligations. Treasury officials, however, have maintained that there is no formal legal authority to establish priorities to pay obligations. In other words Treasury is required to make payments on obligations as they come due. The Congressional Research Service, however, has pointed to two different interpretations: In August 2012, the Treasury Inspector General stated that "Treasury officials determined that there is no fair or sensible way to pick and choose among the many bills that come due every day." In 1985, however, the Government Accountability Office (GAO) wrote to then-Chairman Bob Packwood of the Senate Finance Committee that it was aware of no requirement that Treasury must pay outstanding obligation in the order in which they are received.

Some have argued that the federal government would be required to develop and use some sort of decision-making rule to determine whether to pay obligations in the order they are received or alternatively to prioritize which obligations to pay while other obligations would go into an unpaid queue. The overarching fact is that the federal government's inability to borrow or use other means of financing implies that payment of some or all bills or obligations would be delayed.

Will Congress Act? What Will Come of the Negotiations?

Since the government shutdown, the House of Representatives has passed several bills to open parts of the government. The Senate has rejected this approach, saying that all the House needs to pass is a CR that opens all the government and that no program should be left behind.

While negotiators from both parties have publicly stated they do not prefer to shut down the government or breach the debt ceiling, each side also believes it is the other who must compromise to reach solutions. What these solutions will look like ultimately depends on a variety of factors, many of which may yet to be seen. Since the government shutdown, a number of issues have been raised that could be included in a negotiated package. At this writing, the House leadership is considering a six-week debt limit increase tied to negotiations for a larger legislative package that could include entitlement and tax reforms, and adjustments to the sequester. A number of other issues could always be included in negotiations.

Conclusion

The current situation is unusual. For those who need certainty, it is a situation that has created uncertainty. For those interested in legislative changes in programs, it may be frustrating to have issues mixed in with larger economic issues or with the issue of a government shutdown. However, those interested in legislative changes in programs must remain on watch for what may be included in a larger legislative package of changes in a variety of programs that will be triggered by the debate over funding the government and the debate about the debt limit.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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