Paying Down the Federal Debt: A Discussion of Methods

CRS Report for Congress
Received through the CRS Web
Paying Down the Federal Debt:
A Discussion of Methods
James M. Bickley
Specialist in Public Finance
Government and Finance Division
Summary
Beginning with fiscal year 1998, the federal government began running budget
surpluses; that is, the flow of revenue into the U.S. Treasury exceeded the outflow of
expenditures. The Treasury lowered the amount of outstanding publicly held debt by
reducing new debt issuance as existing federal debt issues matured. In addition, on
March 9, 2000, the Treasury conducted its first buyback operation of outstanding
Treasury securities before maturity. As of January 25, 2002, the Treasury had re-
purchased outstanding Treasury securities with a total par value of $63.5 billion. This
report examines these two methods of paying down the publicly held debt and discusses
estimates of the publicly held debt that could not be retired by the end of FY2011.
Recent budget projections indicate that the U.S. government will incur deficits in fiscal
years 2002 and 2003. Hence, at least in the near term, the publicly held debt will no
longer be paid down but instead will increase. This report will not be updated.
Beginning with fiscal year 1998, the federal government began running budget
surpluses; that is, the flow of revenue into the U.S. Treasury exceeded the outflow of
expenditures. Consequently, the Treasury reduced the amount of outstanding publicly held
debt.¹ This report examines the Treasury’s methods of reducing the publicly held debt.²
In January 2001, the Congressional Budget Office (CBO) reported that the budget
surplus was $236 billion in fiscal year 2000. CBO’s baseline projections of the budget

¹ The sum of publicly held federal debt and federal debt held in government accounts equals total
federal debt. For an explanation of the relationship between budget surpluses (and deficits) and
different concepts of federal debt, see CRS Report RS20767, How Budget Surpluses Change
Federal Debt, by Philip D. Winters.
² For an examination of some economic consequences of eliminating the publicly held debt, see
CRS Report RL30614, What If the National Debt Were Eliminated? Some Economic
Consequences, by Marc Labonte.
Congressional Research Service ˜ The Library of Congress

showed rising budget surpluses through fiscal year 2011; consequently, the publicly held
debt was projected to decline in nominal dollars through fiscal year 2011.³ In January
2001, CBO’s baseline projections indicated that the publicly held debt would decline from
year to year as follows: $3,410 billion (FY2000 actual), $3,148 billion (FY2001), $2,848
billion (FY2002), $2,509 billion (FY2003), $2,131 billion (FY2004), $1,714 billion
(FY2005), and $1,251 billion (FY2006).⁴ After FY2006, CBO’s projected surpluses
would result in the Treasury’s cash on hand exceeding its ability to retire debt held by the
public. Hence, CBO’s projections of the amount of publicly held debt “simply assume[d]
that the Treasury ... [would] ... accumulate all funds exceeding the amounts needed to
retire available debt.”⁵
Methods of Paying Down the Debt
When the government first began running surpluses in FY1998, the Treasury used
only one method to pay down the debt–reducing new debt issuance. Today, the Treasury
has another method–buying back outstanding debt.⁶
Reduction and Elimination of New Debt Issuance.
All publicly held debt eventually matures. To reduce the debt outstanding, the
Treasury issued smaller replacement issues, issued securities less frequently, and
discontinued the issuance of particular maturities. For example, on May 6, 1998, the
Treasury announced that it would stop issuing three-year notes after May 1998, and that
the auctions of five-year notes would be changed to quarterly auctions from monthly
auctions.⁷ The dollar volume of new debt issued was less than the dollar volume of
maturing debt; consequently, the dollar volume of outstanding publicly held debt declined.
Buybacks of Outstanding Debt.
On August 4, 1999, the Treasury published for comment proposed rules for
permitting it to buy back outstanding debt securities before maturity.
Lawrence H. Summers, the Secretary of the Treasury, stated that buyback of debt
would offer the following three advantages:
First, by prepaying the debt we would be able to maintain larger auction sizes than
would otherwise be possible. Enhancing the liquidity of Treasury’s benchmark

³ For an examination of the accuracy of budget projections, see CRS Report RL30854, Uncertainty
in Budget Projections, by Philip D. Winters.
⁴ U.S. Congressional Budget Office, The Budget and Economic Outlook: Fiscal Years 2002 - 2011
(Washington: GPO, Jan. 2001), p. 15.
⁵ Ibid., pp. 15-16.
⁶ For an overview of federal debt management, see CRS Report 98-370 E, Federal Debt
Management: An Overview of Concepts and Policy Options, by James M. Bickley.
⁷ John M. Berry, “Treasury to Reduce Sales of Securities,” The Washington Post, May 7, 1998,
p. E4.

securities should lower the government’s interest costs over time and promote overall
market liquidity.
Second, by paying off debt that has substantial remaining maturity, we would be able
to prevent what would otherwise be a potentially costly and unjustified increase in the
average maturity of our debt: from just over five years to more than seven years on the
current trajectory.
Third, by paying off debt, we can absorb excess cash at times of the year when tax
revenues exceed immediate spending needs. This kind of absorption is an important⁸
part of sound debt management.
On January 13, 2000, the Treasury announced that during calendar year 2000 it
would purchase outstanding Treasury securities before maturity worth as much as $30⁹
billion. On January 19, 2000, the Treasury published its final rules, which adopted the
proposed rules without significant changes. Under the final rules, redemption prices would
be determined through a process in which market participants would submit competitive
offers to sell particular Treasury securities back to the Treasury.¹⁰ On March 9, 2000, the
Treasury bought back $1 billion in Treasury bonds in its first debt buyback in calendar year

2000.¹¹^, ¹² As of January 25, 2002, the Treasury had conducted buyback operations of¹³

outstanding Treasury securities with a total par value of $63.5 billion.
Through fiscal year 2011, the magnitude of the maximum possible reduction in the
publicly held debt was controversial. Non-retireable debt can be classified as marketable
debt and non-marketable debt. Marketable debt can be readily purchased or sold on
financial markets. For example, Treasury coupon bonds are actively traded. Non-
marketable debt cannot be sold on financial markets. For example, savings bonds and state
and local government series debt (used to house state and local bond proceeds
temporarily) are non-marketable.

⁸ U.S. Dept. of the Treasury, Treasury News, Statement of Lawrence H. Summers, Secretary of
the Treasury, Washington, Aug. 4, 1999, p. 2.
⁹ Yichi J. Dreazen and Gregory Zuckerman, “Treasury Announces Its Plan to Buy Back Debt of
as Much as $30 Billion, Above Expectations,” The Wall Street Journal, Jan. 14, 2000, p. C19.
¹⁰ For a presentation of the final rules, see: U.S. Dept. of the Treasury, Fiscal Service,
“Marketable Treasury Securities Redemption Operations,” Federal Register, vol. 65, no. 12, Jan.

19, 2000, pp. 3,114-3,118.

¹¹ U.S. Dept. of the Treasury, “Treasury Announces Debt Buyback Operation,” Treasury News,
March 7, 2000, p. 1.
¹² The Treasury last repurchased debt during the Hoover Administration in 1930, as reported in the
following source: Jacob M. Zuckerman, “Treasury Unveils Anticipated Buyback Plan as Bond
Prices Finish with Only Small Gains,” The Wall Street Journal, March 8, 2000, p. C24.
¹³ For a summary of Treasury buyback operations, see:
[http://www.publicdebt.treas.gov/of/ofbuybaksum.htm], visited Jan. 25, 2002.

Projections of Non-Retireable Publicly Held Debt.
Projections varied concerning the amount of publicly held debt that could not be
retired by the end of FY2011 because of different assumptions. For example, assumptions
differed about the willingness of owners of Treasury bonds to sell their bonds back to the
federal government without being paid an “unacceptably high” premium.
The Bush Administration maintained that $1,158 billion was non-retireable by the end
of FY2011.¹⁴ Of this total, $790 billion was marketable debt consisting of $677 in coupon
issues (non-matured 10 and 30 year bonds) and $113 billion in inflation-indexed issues
(non-matured 10 and 30 year bonds).¹⁵
OMB [the Office of Management and Budget] estimates that it would cost between $50-
$150 billion in bonus payments to entice these holders to give up their bonds. It makes
more sense to let this debt mature naturally, leaving the Nation on a glide path to zero
debt after 2011.¹⁶
The other $368 billion was non-marketable debt consisting of savings bonds ($170 billion);
state and local government series ($86 billion); bonds backing up emerging market Brady
bonds, maturing between 2019-2023 ($19 billion); bonds issued as part of the savings and
loan clean-up, maturing between 2019-2030 ($30 billion); and “other” debt ($63 billion).¹⁷
The Congressional Budget Office projected that $818 billion was non-retireable by
the end of FY2011.¹⁸ CBO assumed that after 2002 the magnitude of the Treasury’s debt
buyback effort would decline because most holders of outstanding 30-year bonds would¹⁹
not “... sell them at prices that the government is willing to pay.” CBO assumed that
non-marketable debt (for example, savings bonds or securities issued to state and local
governments) that serves other purposes besides financing government activities would
continue to be issued.²⁰ Lastly, CBO assumed that “no debt with a maturity of five years²¹
or more will be issued after 2002.”
On March 2, 2001, Alan Greenspan, Chairman of the Federal Reserve Board of
Governors, testified before the House Budget Committee that
As of January 1, ... there was in excess of three quarters of a trillion dollars in
outstanding nonmarketable securities, such as savings bonds and state and local series

¹⁴ U.S. Executive Office of the President, Office of Management and Budget, A Blueprint for New
Beginnings, A Responsible Budget for America’s Priorities (Washington: GPO, 2001), p. 31.
¹⁵ Ibid.
¹⁶ Ibid., p. 30.
¹⁷ Ibid., p. 31.
¹⁸ Congressional Budget Office, The Budget and Economic Outlook: Fiscal Years 2002 - 2011
(Washington: GPO), Jan. 2001, pp. 13-15.
¹⁹ Ibid., p. 15.
²⁰ Ibid.
²¹ Ibid.

issues, and marketable securities (excluding those held by the Federal Reserve) that do
not mature and could not be called before 2011. Some holders of long-term Treasury
securities may be reluctant to give them up, especially those who highly value the risk-
free status of those issues. Inducing such holders, including foreign holders, to willingly
offer to sell their securities prior to maturity could require paying premiums that far
exceed any realistic value of retiring the debt before maturity.²²
But, Gary Gensler, former Treasury Undersecretary for Domestic Finance during the
Clinton Administration, stated that
close to $3.0 trillion of the currently outstanding 3.4 trillion in publicly held debt could
be paid off, leaving outstanding between $410 and $500 billion in debt at the end of ten
years. I believe that Treasury can achieve this in the future, by: (1) allowing the vast
majority of this debt to mature as it comes due; (2) making various changes to debt
management policies over time; and (3) smoothly repurchasing over time the majority
of Treasury’s long term debt at market level prices.²³
He maintained that the Treasury could discontinue issuance of any new longer-term debt,
continue to buy back long-term debt, and begin exchanging short-term debt for long-term
outstanding debt.²⁴ Furthermore, he stated that the Treasury could discontinue issuing
special non-marketable securities for state and local governments, which then would invest
in alternative debt instruments.²⁵ Lastly, he asserted that the Thrift Savings Plan for
federal employees (equivalent to a 401K program) could replace its Treasury securities
fund option with a new private bond fund.²⁶
Return of Deficits.
During fiscal year 2001, the U.S. government had a budget surplus of $127 billion,
which was below CBO and OMB projections for three primary reasons. First, in March
2001, a recession started that lowered revenues and raised expenditures. Second, revenue
growth was reduced by tax cuts in the Economic Growth and Tax Relief Reconciliation
Act of 2001 (P.L. 107-16), which was signed by President Bush in June 2001. Third, the
terrorist attacks on September 11, 2001, had negative effects on the budget and further
lowered the surplus at the end of fiscal year 2001. All three of these factors have carried
over into fiscal year 2002.
On January 23, 2002, Dan L. Crippen, Director of CBO, stated the new CBO
baseline projected deficits for fiscal years 2002 and 2003.²⁷ CBO’s baseline projections

²² Testimony of Alan Greenspan, Chairman of the Federal Reserve Board of Governors, before the
House Budget Committee on March 2, 2001.
²³ Letter from Gary Gensler, former Treasury Undersecretary for Domestic Finance in the Clinton
Administration, to Rep. John Spratt on Feb. 27, 2001.
²⁴ Ibid.
²⁵ Ibid.
²⁶ Ibid.
²⁷ Congressional Budget Office, The Budget and Economic Outlook: Fiscal years 2003-2012,
(continued...)

“are constructed according to rules set forth in law and long-standing practices and are
designed to project federal revenues and spending under the assumption that current laws
and policies remain unchanged.”²⁸ But, on January 23, 2002, President Bush stated that
his 2003 budget would include a large increase in spending on defense and homeland
security.²⁹ He indicated that the federal budget would incur a deficit of $106 billion for
fiscal year 2002 and $80 billion for fiscal year 2003.³⁰ Mitch Daniels, Director of OMB,
said that the return of deficit spending would cause the federal government’s pay down of³¹
the debt to be stopped temporarily. Both CBO’s baseline projections and OMB’s budget
proposals indicate that surpluses reoccur; consequently, within several years, the Treasury
may again begin reducing the publicly held debt.

²⁷ (...continued)
Statement of Dan L. Crippen, Director, before the Senate Committee on the Budget, Washington,
Jan. 23, 2002, p. 1.
²⁸ Ibid., p. 2.
²⁹ Nancy Ognanovich, “Bush Proposing $50 Billion Defense Hike in Plan Marking Return to
Deficit Spending,” Daily Tax Report, no. 14, Jan. 24, 2002, p. G9.
³⁰ Ibid.
³¹ Ibid.