Washington Update – Government Shutdown and Debt Ceiling: A Primer

Even before Congress returned to work this week, House and Senate Republicanleadership warned their caucuses about the political consequences of shuttingthe 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 toexhausting all of its extraordinary means for paying its obligations unless thedebt ceiling was raised. He anticipates that the debt ceiling will need to beraised sometime after October. To aid understanding of these discussions, wehave prepared this explanation of the basics.

The continuing resolution (defined below) and the debt ceiling are twodifferent concepts designed to address two different situations. A governmentshutdown occurs because there is no authority to obligate funds. By contrast, ina situation in which the debt limit is reached and Treasury exhausts itsfinancing alternatives, aside from ongoing cash flow, an agency may continue toobligate funds. However, Treasury cannot borrow to meet federal outlays due to ashortage of cash.

When Congress passes appropriations bills and the President signs them,authority to obligate funds is created. This Congress has yet to send anappropriation bill to the President to sign. It is not likely that Congress willbe 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 keepthe federal government operating. This short-term funding bill is known as acontinuing resolution.

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

Two separate disputes have become intertwined. While the White House and manyin Congress may agree that government-wide automatic spending cuts, known assequestration, need to be replaced with actual spending policy, there isdisagreement over what that policy should be. The sticking points between theWhite House and Congressional Republicans are over cutting military spendingversus cutting domestic spending. The second issue concerns Planned Parenthood.Republicans want to cut off government spending to Planned Parenthood, in thewake of publicly released hidden camera videos discussing reimbursement forfetal tissue, even though the Senate already failed to cut such spending beforeit recessed in August. Planned Parenthood receives about $500 million in federalfunds annually.

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

Continuing Resolution (CR)

Congress must provide legislation to authorize budget authority for mostfederal agencies and programs on an annual basis. This usually is achievedthrough the passage of appropriations bills. However, should the fiscal yearbegin without the annual appropriations bills enacted, Congress must resort to astopgap spending measure known as a continuing resolution (CR) to keep federalagencies operational while longer-term legislation can be considered. A “cleanCR” refers to such a stopgap measure that largely maintains current spendinglevels and does not contain non-budgetary policy provisions. A CR, however, canchange the spending levels of the federal programs it funds.

Mandatory vs. Discretionary Funding

Some programs are considered “mandatory” spending. Unlike the national parksand 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 mandatoryexpenditures, accounting for about 73 percent of mandatory spending. Variousincome security programs such as SNAP, unemployment compensation, and earnedincome and child tax credits account for an additional 18 percent of mandatoryspending.

Medicare

In the short term, the Medicare program, because the benefits that it paysbeneficiaries constitute mandatory spending, will continue largely withoutdisruption, despite the lapse in appropriations. Additionally, othernondiscretionary 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 MedicaidServices (CMS) would be unable to continue discretionary funding for healthcarefraud and abuse strike force teams, resulting in the cessation of theiroperations. Because a potential consequence of a government shutdown includesfewer recertification and initial surveys for Medicare and Medicaid providersbeing completed, beneficiaries would be at risk for a lower quality of care. Inaddition, the longer the government is shut down, the greater the likelihood ofa longer lag time in claims being processed for payment.

Medicaid

Because Medicaid allotments are paid to states on a quarterly basis, it islikely states will not see an immediate impact from a temporary governmentshutdown. Thus, providers who service Medicaid and SCHIP patients should not seea disruption in payment initially. However, like Medicare, the longer theshutdown, 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 governmentdown unless Planned Parenthood is defunded. The political concern is that few inthe public remember the issues for which Congress failed to fund the government.Yet, those frustrated by certain policies see the funding fight − because it isa 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 thata shutdown will occur, in part because of the weight of the issues that willconsume Congress’ attention in September, and because the actual time Congressis in session in September is short.

Debt Ceiling

Under normal circumstances, partly due to its ability to borrow funds, theTreasury has sufficient financial resources to pay all obligations arising fromdiscretionary and mandatory spending, including interest payments on the debt.However, Treasury estimates that it will exhaust its borrowing capacity shortlyafter the end of October. On July 29, Secretary Lew wrote:

On March 16, 2015, the outstanding debt of the United States reached thestatutory limit. As a result, Treasury had to begin employing extraordinarymeasures to continue to finance the government on a temporary basis. Thesemeasures, which we have used in previous debt limit impasses, include a debtissuance suspension period with respect to investments of the Civil ServiceRetirement and Disability Fund and a suspension of the daily reinvestment ofTreasury securities held by the Government Securities Investment Fund of theFederal Employees’ Retirement System Thrift Savings Plan. The debt issuancesuspension period currently lasts until July 30. Tomorrow, I expect toextend 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 havebeen employing to preserve borrowing capacity would not be exhausted beforelate October, and that they likely would last for at least a briefadditional period of time. That continues to be our view, based upon ourbest and most recent information.

Since my previous letter, I have taken additional action to implement theextraordinary measures that allow us, on a temporary basis, to continuepaying the nation’s bills. Specifically, on August 31, I suspended, asnecessary, the daily reinvestment of the portion of the ExchangeStabilization Fund that is invested in Treasury securities. Each of themeasures employed to date is authorized by law, and each has been usedduring past debt limit impasses. The effective duration of these measuresdepends on factors that are inherently variable and irregular, including theunpredictability of tax receipts and changes in expenditure flows. IfTreasury exhausts these measures, the United States will have reached thelimit of its borrowing authority, and Treasury would be left to fund thegovernment with only the cash on hand on any given day.

Earlier this year, Treasury implemented a new policy of maintaining acash balance generally sufficient to cover one week of outflows, subject toa minimum of roughly $150 billion. In a public release, we explained thatthe policy will help protect against a potential interruption in marketaccess resulting from events such as Hurricane Sandy, September 11, or apotential cyber-attack. Maintaining this higher cash balance does notincrease the debt limit, nor does it alter in any way the length of timeTreasury can continue to pay the nation’s bills. On August 19, our cashbalance fell below this minimum level. We anticipate that it will risetemporarily after the September 15 deadline for corporate and individual taxreceipts − possibly above $150 billion − and then will decline again.

Extraordinary Measures and Background :

Beginning in 1789 and for approximately 130 years thereafter, Congressgenerally had to act each and every time Treasury needed to borrow money. SinceWorld War I, however, Congress has provided Treasury with increasing flexibilityto 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 congressionalaction. That is the debt ceiling. Treasury cannot borrow more unless Congressvotes 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 managementresponsibilities. 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 thegovernment’s computers would keep printing checks and some would bounce, unlessa debt ceiling increase limit had been passed. At the very least, the governmentwould 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 governmentsecurities, or redeems prematurely a federal trust fund’s holdings of governmentsecurities, 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) andaccelerate insolvency dates. Congress passed PL 104-121 to prevent federalofficials from using the Social Security and Medicare trust funds for debtmanagement purposes except when necessary to provide the payment of benefits andadministrative expenses of the program.

The Social Security and Medicare trust funds were created to account formonies that are dedicated to those programs. The fund accounts maintained by theDepartment of the Treasury provide a mechanism for keeping track of all programincome and disbursements. Accumulated assets of the funds represent automaticauthority to pay program benefits (that is, no annual legislation is needed tospend a portion of trust fund assets on these costs). If the trust funds wereexhausted, congressional action would be needed to pay benefits not covered bycurrent program revenues.

While the trust funds are treated separately under budget rules, what isimportant to understand is the flow of funds between general revenue and therespective trust funds. The Medicare program has two trust funds: the HospitalInsurance (HI) and the Supplementary Medical Insurance (SMI) trust funds. The HItrust fund is financed primarily by payroll contributions. Other income includesa small amount of premium revenue from voluntary enrollees, a portion of thefederal income taxes beneficiaries pay on Social Security benefits, and interestcredited on the U.S. Treasury securities held in the HI trust fund. Parts B andD 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 monthlypremiums.

When a trust fund invests in U.S. Treasury securities, it has loaned money tothe rest of the government. The value of the securities held is recorded in thebudget as “debt held by government accounts” and represents debt owed by onepart of the government to another. The securities constitute a liability for theTreasury because the loan must be repaid when the trust fund needs to redeemsecurities in order to make benefit payments. As with marketable bonds, theseTreasury 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 accountfrom which purchases of all sorts can be made, while the trust funds representretirement savings accounts with specific rules for withdrawals. For example,the SMI trust fund receives large transfers from the general fund, with the sizeof each depending upon how much the program spends, as opposed to how muchrevenue comes into the Treasury. If non-dedicated revenues become insufficientto cover both the mandated transfer to SMI and expenditures on generalgovernment programs, Treasury must borrow to make up the difference. In the longrun, if there is insufficient funding to meet obligations, and Treasury cannotborrow to make up the difference, Congress must allow Treasury to borrow, raisetaxes, 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 toavoid a default on federal obligations by paying interest on outstanding debtbefore other obligations. Treasury officials, however, have maintained thatthere is no formal legal authority to establish priorities to pay obligations.In other words Treasury is required to make payments on obligations as they comedue. The Congressional Research Service, however, has pointed to two differentinterpretations. In August 2012, the Treasury Inspector General stated that“Treasury officials determined that there is no fair or sensible way to pick andchoose among the many bills that come due every day.” In 1985, however, theGovernment Accountability Office (GAO) wrote to then-Chairman Bob Packwood ofthe Senate Finance Committee that it was aware of no requirement that Treasurymust pay outstanding obligations in the order in which they are received.

Some have argued that the federal government would be required to develop anduse some sort of decision-making rule to determine whether to pay obligations inthe order they are received or, alternatively, to prioritize which obligationsto pay while other obligations would go into an unpaid queue. The overarchingfact is that the federal government’s inability to borrow or use other means offinancing implies that payment of some or all bills or obligations would bedelayed.

Congressional Action

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

Conclusion

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

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If you have any questions, contact the following individuals atMcGuireWoods Consulting:

StephanieKennan, Senior Vice President
Charlyn Iovino, VicePresident

Founded in 1998, McGuireWoods Consulting LLC (MWC) is a full-service public affairs firm offering state and federal government relations, national/multistate strategies, infrastructure and economic development, strategic communications and grassroots issue management services. McGuireWoods Consulting is a subsidiary of the McGuireWoods LLP law firm and in 2010 was ranked in the Top 20 of The National Law Journal‘s “The Influence 50,” an annual report of the top public affairs firms in Washington, D.C.

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