Debt limit restrictions
Debt limit restrictions cap the amount of debt that a governmental entity may have outstanding at a given time. The most common types of restrictions cap debt once it reaches a nominal dollar amount, but caps can also be set once debt service reaches a particular amount, once debt reaches a percentage of a particular revenue stream and numerous other variations. Debt limit restrictions can be implemented at federal, state and local levels, and can be statutory or constitutional. This policy is intended to constrain the ability of governments to borrow excessively.
- Goal: Decrease projected budget gaps
- Goal: Decrease budgeted funding for ineffective or unnecessary expenditures
- Goal: Decrease the rate of government taxation
- Goal: Increase the rating of government credit
The government of a state decides that it must make controlling deficits and cutting spending a priority. It enacts a statutory limit on the nominal amount of general obligation bonds that it can have outstanding at any time. The state’s treasury would then be legally prohibited from issuing debt for any reason if total debt reaches the limit. Legislators would be forced to consider these requirements when enacting spending legislation. If, for example, legislators wanted to make investments in an athletic facility at a state university, any debt issuance associated with this project would have to comply with the debt limit. By limiting the amount of debt that can be issued to finance such projects, the debt limit effectively limits the scope of projects that legislators can enact. As a consequence of reduced debt, legislators can devote fewer revenues to debt service and more to other activities.
Tradeoffs of implementing this policy may include:
- State: Decreased capability for states to fund needed long-term capital projects
- State/Federal: Debt limits may not always reflect actual debt capacity
- Federal: Increased risk of default if debt ceiling not raised
- Federal: Can lead to indiscriminate spending cuts to programs that hurt low-income individuals
- Federal: Potential to disrupt normal budget process
If answered yes, the following questions indicate superior conditions under which the policy is more likely to be appropriate:
- Is debt typically issued to finance long-term, capital expenditures as opposed to day-to-day governmental operations?
- Would a debt limit not increase the risk that an entity could default on its obligations?
- Is the entity at risk of not being able to make debt service payments?
- Would a debt limit lead legislators to enact more fiscally prudent policies?
- Does the entity have a history of taking on too much debt?
The following questions should be considered when determining how to implement this policy:
- Will the debt limit be set as a nominal dollar amount? Or will it be set as a percentage of debt service, revenue level, or some other metric?
- What types of debt are subject to limitations?
- How will legislators be held to debt limits?
- How large are outstanding obligations that require the issuance of debt?
- What is the debt capacity of the entity?
- For issue type(s): Finance.
- Notable entities who have implemented or adopted this policy include all fifty U.S. States and the U.S. Government:
- Advocates - Regressive Taxation. Assumption: Supporters of regressive taxation and fiscal conservatives tend to be overwhelmingly Republican in the United States. Such individuals tend to prefer balanced budgets and decreased spending, both of which are enforced by debt limit restrictions. 
- Advocates - Fiscal Conservatives. 
- Labor Unions - Civil Service. Assumption: Public sector unions tend to oppose measures that reduce government spending, as they generally lead to pay cuts, layoffs and reduced benefits for these employees. 
- Advocates - Progressive Taxation. Assumption: Supporters of progressive taxation tend to be economically liberal and supportive of a stronger welfare state. Debt limits often result in spending cuts, which adversely impact programs aimed at helping low income individuals. 
- Bunch, Beverly. "The effect of constitutional debt limits on state governments' use of public authorities". Public Choice. January 1991, Volume 68, Issue 1, pp 57-69.
- Poterba, James M. and Reuben, Kim. "State Fiscal Institutions and the U.S. Municipal Bond Market". National Bureau of Economic Research. January 1999, pp 187-207.
- Liu, Pu, Shao, Yingying and Yeager, Timothy J.. "Did the repeated debt ceiling controversies embed default risk in US Treasury securities?". Journal of Banking & Finance. August 2009, Volume 33, Issue 8, pp 1464–1471.