Even before Congress returned to work this week, House and Senate Republican leadership warned their caucuses about the political consequences of shutting the government down when this fiscal year ends on September 30. In addition, this week, U.S. Treasury Secretary Jacob Lew said the government was close to exhausting all of its extraordinary means for paying its obligations unless the debt ceiling was raised. He anticipates that the debt ceiling will need to be raised sometime after October. To aid understanding of these discussions, we have prepared this explanation of the basics.

The continuing resolution (defined below) 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.

When Congress passes appropriations bills and the President signs them, authority to obligate funds is created. This Congress has yet to send an appropriation bill to the President to sign. It is not likely that Congress will be able to pass 12 separate appropriation bills before the end of the month, which means it will have to pass a short-term funding bill to continue to keep the federal government operating. This short-term funding bill is known as a continuing resolution.

Why is a government shutdown a possibility (again) this year?

Two separate disputes have become intertwined. While the White House and many in Congress may agree that government-wide automatic spending cuts, known as sequestration, need to be replaced with actual spending policy, there is disagreement over what that policy should be. The sticking points between the White House and Congressional Republicans are over cutting military spending versus cutting domestic spending. The second issue concerns Planned Parenthood. Republicans want to cut off government spending to Planned Parenthood, in the wake of publicly released hidden camera videos discussing reimbursement for fetal tissue, even though the Senate already failed to cut such spending before it recessed in August. Planned Parenthood receives about $500 million in federal funds annually.

Other issues also can play into the funding debate. For example, Congress let the Export-Import Bank expire in June and a government funding bill could be a vehicle to debate restarting the agency. Congress also has to spend time debating the Iran Nuclear Agreement − time that might otherwise go toward working out a funding deal.

Continuing Resolution (CR)

Congress must provide legislation to authorize budget authority for most federal agencies and programs on an annual basis. This usually is achieved through the passage of appropriations bills. However, should the fiscal year begin without the annual appropriations bills 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 and does not contain non-budgetary policy provisions. A CR, however, can change the spending levels of the federal programs it funds.

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. Social Security, Medicare and Medicaid are the largest individual mandatory expenditures, accounting for about 73 percent of mandatory spending. Various income security programs such as SNAP, unemployment compensation, and earned income and child tax credits account for an additional 18 percent of mandatory spending.

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 lapse in appropriations. Additionally, other nondiscretionary activities including Health Care Fraud and Abuse Control (HCFAC) and some activities by the Center for Medicare & Medicaid Innovation (CMMI) are likely to continue. However, the Centers for Medicare and Medicaid Services (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 at risk for a lower quality of care. In addition, the longer the government is shut down, the greater the likelihood of a longer lag time in claims being processed for payment.

Medicaid

Because Medicaid allotments are paid to states on a quarterly basis, it is likely states will not see an immediate impact from a temporary government shutdown. Thus, providers who service Medicaid and SCHIP patients should not see a disruption in payment initially. However, like Medicare, the longer the shutdown, the more likely a lag in processing claims could be experienced

Will Congress Act?

At this writing, 28 House Republicans have pledged to shut the government down unless Planned Parenthood is defunded. The political concern is that few in the public remember the issues for which Congress failed to fund the government. Yet, those frustrated by certain policies see the funding fight − because it is a must-pass legislative vehicle – as an opportunity to raise their issues. Expert budget watchers give the odds as well over 50 percent to 75 percent that a shutdown will occur, in part because of the weight of the issues that will consume Congress’ attention in September, and because the actual time Congress is in session in September is short.

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, Treasury estimates that it will exhaust its borrowing capacity shortly after the end of October. On July 29, Secretary Lew wrote:

On March 16, 2015, the outstanding debt of the United States reached the statutory limit. As a result, Treasury had to begin employing extraordinary measures to continue to finance the government on a temporary basis. These measures, which we have used in previous debt limit impasses, include a debt issuance suspension period with respect to investments of the Civil Service Retirement and Disability Fund and a suspension of the daily reinvestment of Treasury securities held by the Government Securities Investment Fund of the Federal Employees’ Retirement System Thrift Savings Plan. The debt issuance suspension period currently lasts until July 30. Tomorrow, I expect to extend the debt issuance suspension period through October 30.

In his letter of September 10, Secretary Lew said:

On July 29, I wrote to inform you that the extraordinary measures we have been employing to preserve borrowing capacity would not be exhausted before late October, and that they likely would last for at least a brief additional period of time. That continues to be our view, based upon our best and most recent information.

Since my previous letter, I have taken additional action to implement the extraordinary measures that allow us, on a temporary basis, to continue paying the nation’s bills. Specifically, on August 31, I suspended, as necessary, the daily reinvestment of the portion of the Exchange Stabilization Fund that is invested in Treasury securities. Each of the measures employed to date is authorized by law, and each has been used during past debt limit impasses. The effective duration of these measures depends on factors that are inherently variable and irregular, including the unpredictability of tax receipts and changes in expenditure flows. If Treasury exhausts these measures, the United States will have reached the limit of its borrowing authority, and Treasury would be left to fund the government with only the cash on hand on any given day.

Earlier this year, Treasury implemented a new policy of maintaining a cash balance generally sufficient to cover one week of outflows, subject to a minimum of roughly $150 billion. In a public release, we explained that the policy will help protect against a potential interruption in market access resulting from events such as Hurricane Sandy, September 11, or a potential cyber-attack. Maintaining this higher cash balance does not increase the debt limit, nor does it alter in any way the length of time Treasury can continue to pay the nation’s bills. On August 19, our cash balance fell below this minimum level. We anticipate that it will rise temporarily after the September 15 deadline for corporate and individual tax receipts − possibly above $150 billion − and then will decline again.

Extraordinary Measures and Background :

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 I, 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. Treasury cannot borrow more unless Congress votes to raise the ceiling.

In the past, Treasury Secretaries, when facing 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).

So what will happen once the debt ceiling is hit? One scenario is that the government’s computers would keep printing checks and some would bounce, unless a debt ceiling increase limit had 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, with the size of each depending 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 It Pays?

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 obligations 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.

Congressional Action

On September 10, the House Ways and Means Committee reported the “Default Prevention Act,” H.R 692. This legislation would give the Treasury Department authority to borrow in order to pay interest on the debt, should the government hit the debt ceiling and new borrowing authority has not yet been passed. It is unclear when and if the Senate will consider this legislation.

Conclusion

While several political issues have intertwined to make a government shutdown a possibility, so too have intertwined issues made the debt ceiling issue complicated. Raising the debt ceiling does not in itself increase government spending, but there are policymakers who want to use the debt ceiling debate as a means to extract policies to decrease spending. The federal government has yet to default on its obligations, even though political debate has created uncertainty in the recent past and may do so again this year.