The Debt Ceiling: An Affectionate History
Remember the movie Groundhog Day? The protagonist, played by Bill Murray, is stuck in a cycle where he relives the same day, February 2, every time he awakens in the small town of Punxsutawney, Pennsylvania. The same events happen throughout the day, time and time again. The events agitate Murray's character, but he falls into a rhythm. Knowing what the town's denizens will do before they do is a source of comfort.
Such is the feeling one gets with what has become America's annual debt ceiling debacle. Congress nears the limit on debt the federal government can issue and gets together to hold a vote on whether to lift it. The public sweats it out with anticipation, waiting anxiously to see whether the country's government will continue operations or if lack of funds will halt the whole enterprise. After much hand-wringing and debate, Congress lifts the debt limit and the crisis is averted. Hurrah! yells the crowd, as it can now get back to its life. Cooler heads prevailed and the stalemate was broken for the good of the country.
That's a quaint, though accurate, rendition of the events that transpire each time the federal debt level nears the ceiling.
The debt ceiling is an oddly American phenomenon. Prior to 1917, Congress would authorize the Treasury on a case-by-case basis when taxation could not meet the government's spending wants. Every year between 1788 and 1917, Congress authorized each Treasury bond issued.
World War I changed this long-standing situation. The Second Liberty Bond Act of 1917 allowed the Treasury to issue bonds without congressional approval, subject to a statutory limit. This Act limited the total amount of debt by setting caps on individual debt categories (e.g., bonds, bills, etc.).
As World War II raged on, Congress changed the limit to apply the ceiling on the total amount of federal debt without reference to specific forms of debt. The debt ceiling as we understand it today is the result of the United States Public Debt Act of 1939. The act eliminated the separate limits on the different types of government debt. It also consolidated nearly all federal borrowing under the Department of the Treasury.
Each year or so, when the Treasury's poor financial management skills bring it to Congress to request an increase in the debt limit, we see the following graph. The historical progression of the ceiling is uniformly upward.
From its low initial limit of $49 billion in 1940, Congress has voted to raise the limit eighty times. Today the cap stands at $28,500,000,000,000 (I'll save you the trouble of counting: that's $28.5 trillion).
I've made a slight change in this graph. There is a dashed line that starts in February 2013. That month, instead of voting to increase the debt limit, Congress voted to suspend it. This temporary suspension ended in May of that year. Since then, Congress has voted to suspend the debt limit temporarily a total of four times more.
The suspension works by doing away (temporarily, of course) with one of the key restraints that Congress has over the executive branch: the purse strings. During the suspension of the celling, the federal government can issue as much debt as it wants. At the end of the temporary suspension, the debt ceiling adjusts upward to the new level of debt.
You can see from the prevalence of the dashed line after 2013 that the debt limit has not been operative for much of the period. These periods of suspension resulted in large increases in the total amount of debt outstanding.
In percentage terms, the largest increase in the debt ceiling came in March 1942, at 92 percent. In absolute terms, the $1.9 trillion increase in February 2010 was the largest.
It's a little hard to get a feel for the debt ceiling over history by focusing on its nominal value. We can make it easier to understand by adjusting the level for inflation. The message is still roughly the same, though with a point of distinction.
Although the upward trajectory is still clear, the trend has two punctuations.
The first was the prolonged period between April 1945 and October 1984. In real terms, the debt ceiling peaked at the end of World War II at $4.6 trillion. It would not surpass this level for another thirty-nine years.
The second period was shorter. The debt limit did not pass its August 1997 peak of $10.1 trillion until May 2003 (in inflation-adjusted terms). Without Congress continually increasing the nominal value of the ceiling, inflation serves the beneficial purpose of eroding its real value. This moderates government spending.
March 1942 saw the largest inflation-adjusted increase to the debt ceiling, at 69 percent. The 2 percent increase in August 1954 was the largest decrease.
The largest inflation-adjusted increase was in February 2010 at $2.3 trillion. Even though Congress voted to increase the limit in August 1954, inflation eroded the value over the previous debt ceiling passed in June 1946. The nominal increase represented a $1.1 trillion decrease in real terms.
The Korean War, which lasted from 1950 to 1953, could have easily escalated into a Vietnam-type quagmire. Congress lifted the debt ceiling eleven times throughout America's involvement in Vietnam but did not touch it once during the Korean War. Congress chose to increase the limit on the federal government's funding by 48 percent to help it continue deepening its involvement in Vietnam. By contrast, taxes paid for most of the Korean War. Over the three-year campaign, the debt ceiling fell by 13 percent in real terms.
This relationship between deficit and inflationary spending and a country's propensity to go to war is well known. The recent end to the Afghanistan War has brought much commentary about the total cost. This reckoning is only half the story. When one speaks of the cost, as in “the total cost of the Afghanistan War was $2.3 trillion,” one usually thinks of it as having been paid already. Congress voted to increase the debt ceiling by 380 percent over the twenty-year period. It will assuredly remain at this elevated level forever. The country will pay interest on this added debt in perpetuity.
I've called this article an “affectionate” history of the debt ceiling, although until now it has not been clear why: for most of its history, the debt ceiling has moved in a one-way direction. This is clearly the case in nominal terms, and we now see it has been the case in real terms since the early 1970s.
For advocates of fiscal restraint, there are some historical green shoots to note. In June 1946, Congress opted to decrease the limit by 8 percent ($25 billion). Congress lowered the limit five times over its history, the last time being June 1963.
Adjusted as a percentage of American GDP, the debt ceiling has had a more volatile trajectory. Of note is that it fell for a prolonged period. After peaking during World War II at 132 percent of GDP, it fell continuously until bottoming at 32 percent in 1974, for a total decline of 76 percent.
It is not a coincidence that this period of fiscal restraint in the United States coincided with the Bretton Woods period. Although not perfect, the forcing of the redeemability of the US dollar into gold by the other major world powers hampered the US profligacy. Unable to take on more debt without consequence, the postwar period of economic growth eroded the relative value of the existing debt.
The Department of the Treasury claims on its website that
[f]ailing to increase the debt limit would have catastrophic economic consequences. It would cause the government to default on its legal obligations—an unprecedented event in American history. That would precipitate another financial crisis and threaten the jobs and savings of everyday Americans—putting the United States right back in a deep economic hole, just as the country is recovering from the recent recession.
The postwar period of economic growth is one of the strongest in US history. There are many reasons why this was the case but keeping the government at bay is one of the strongest ones. The debt ceiling served an important historical purpose. It continues to serve this purpose today. Raising it without limit is not necessary and sets a dangerous signal that fiscal restraint is no longer necessary. With the ceiling higher today than any time since World War II, the country needs that restraint now more than ever.