The Fiscal Red Line: How Close is the U.S. to Its Borrowing Limit?

Introduction

Governments often rely on borrowing to finance spending, stabilize the economy, and respond to emergencies. However, there is a point at which additional debt becomes unsustainable. This point is sometimes called the “fiscal limit” or the level beyond which typical policy responses cannot prevent debt from spiraling upward. A related concept is “fiscal space” refers to the room a government to increase spending or lower taxes without jeopardizing broader financial sustainability. Both are measures of a nation’s fiscal health.

In this paper, I provide an overview of the fiscal limit and fiscal space.1 I also present updated estimates for the United States, illustrating how fiscal space has changed over time. The findings reveal that the fiscal environment in 2025 differs markedly from the period before the enactment of the Tax Cuts and Jobs Act of 2017 (TCJA), largely due to the substantial federal budget deficits incurred since 2020. During this time, remaining fiscal space declined from roughly 73 percent of GDP to about 62 percent.

Based on this analysis there is a clear path forward for the U.S. government to restore fiscal space to its 2017 level while achieving necessary policy goals. With policies designed to raise annual economic growth to 3 percent by 2028, extending the TCJA should be accompanied by an achievable budgetary savings of roughly $100 to $140 billion per year. This approach would set up base level reforms on which to build more comprehensive reforms. Within the next decade, policymakers will still need to address long-term entitlement programs to prevent compounding debt service costs and federal health expenditures from eroding fiscal space entirely.

The Fiscal Limit and Fiscal Space

The fiscal limit is the maximum debt-to-GDP ratio beyond which the government cannot stabilize its finances using its historical pattern of fiscal adjustments. If the U.S. debt ratio surpasses this limit, markets may lose confidence, interest rates could spike, and policymakers might be unable (or unwilling) to raise enough revenues or cut enough spending to keep debt from growing uncontrollably.

Fiscal space refers to the room a government has to undertake additional borrowing without undermining debt sustainability or risking a loss of market confidence. In simple terms, it is the difference between the fiscal limit and the current level of debt.2 Maintaining sufficient fiscal space is a form of insurance against events that have fiscal responses such as war, natural disasters, pandemics, or recessions.

The Role of Interest Rates and Economic Growth

A crucial part of debt sustainability is the interest-growth differential (r−g) where:

• r = the real interest rate paid on government debt, and
• g = the real growth rate of the economy (GDP).

If r < g, the economy grows faster than the real interest cost on the debt. In that scenario, it is easier to sustain higher debt levels without triggering explosive debt dynamics. If r > g, the government must run sufficiently large primary surpluses to keep debt from snowballing.

Estimates of the Fiscal Limit and Remaining Fiscal Space

The methodology and data used to estimate the fiscal space and fiscal limit are in the paper’s appendix. Table 1 shows data and model outputs for the fiscal quarter of 2017 and from the third quarter of 2024 (which reflects the most recent data available). Columns include the real neutral rate (r*) and real GDP growth (g) as estimated by the Federal Reserve Bank of New York,3 then fiscal limit, alongside marketable debt, and the remaining fiscal space implied by each date’s environment (all as a percent of GDP), as calculated.

Table 1. Estimates of the U.S. Fiscal Limit and Fiscal Space.

Sources: BEA, Dallas Fed, New York Fed, and Author’s calculations.

Note: Estimates of r* and g are from the Federal Reserve Bank of New York and based on Holston-Laubach-Williams (2017/2024). Data on marketable debt is from the Federal Reserve Bank of Dallas. Estimates of GDP are from the Bureau of Economic Analysis. Estimates of the fiscal limit and remaining fiscal space are from the author.

Interpretation

The fiscal limit can rise over time especially as potential growth increases. In fact, the fiscal limit increased by 3 percentage points of GDP in part because the fundamentals of the economy improved. However, increases in the fiscal limit were significantly outpaced by the growth in debt. As a result, the fiscal space that is necessary to deal with fiscal shocks has declined significantly despite the increase in the fiscal limit.

One key finding is that the U.S. fiscal limit was about 150 percent of GDP at the end of 2024 based on estimated values of r* and g. This implies that if debt climbs above these levels, the historically observed surplus response may be insufficient to stabilize the debt, thereby increasing the risk of unsustainable debt dynamics.

Over time, debt levels in the United States have been on the rise. In early 2017, the value of marketable debt was around 73 percent of GDP, leaving roughly the same percentage of GDP in available fiscal space. By the third quarter of 2024, however, marketable debt was estimated to be roughly 90 percent of GDP. Therefore, the available fiscal space was at around 62 percent of GDP. This narrowing gap underscores the growing concern that higher debt may constrain future policy options.

Another important insight is that, at present, the real interest rate on debt remains lower than the real GDP growth rate (i.e., r*−g < 0). This phenomenon has so far helped sustain U.S. debt by easing the burden of interest costs relative to economic growth. Even so, it does not eliminate the possibility of future problems including sustained spending on health programs that exceeds economic growth. If interest rates were to rise significantly, or if economic growth were to weaken, the debt burden would become much harder to manage.

Why This Matters

These updated estimates suggest that while the U.S. still retains significant fiscal space, that space has been shrinking as debt rises faster than GDP. If current policies remain unchanged and another major fiscal shock (comparable to the COVID-19 response) occurs, the U.S. could approach or surpass its estimated fiscal limit. In practice, the precise debt limit is uncertain, given the challenges of measuring the natural interest rate and the possibility of different policy environments. Nonetheless, guarding against sudden shifts in interest rates remains crucial for sustaining a comfortable margin of fiscal space.

Understanding these dynamics is essential for several reasons. First, policy flexibility becomes more constrained as the remaining fiscal space narrows. Governments with adequate headroom can respond more aggressively to crises – whether they be economic downturns, national security crises, or natural disasters – without triggering concerns over debt sustainability. Second, perceptions of the U.S. government’s solvency affect investor confidence, as U.S. Treasurys are widely regarded as a safe asset. If markets sense that the U.S. is nearing its debt limit, interest rates could rise abruptly, leading to higher borrowing costs. Finally, the current advantage of economic growth outpacing interest rates may not hold indefinitely. Policymakers would do well to consider measures such as pro-growth reforms and fiscal discipline to help ensure the stability and credibility of U.S. debt over the long run.

Changes in the Economic and Fiscal Environment Since 2017

The economic and fiscal landscape of the United States has evolved significantly since 2017. During the late-2010s, the economy enjoyed relatively robust growth and moderate government deficits, allowing policymakers to keep concerns about debt sustainability in check. However, the shock of the COVID-19 pandemic prompted a sizeable fiscal response which has affected fiscal space.

Fiscal space deteriorated sharply as the government enacted large-scale programs to offset the economic fallout associated with the pandemic and related policy decisions. These measures, combined with lower tax revenues as the government-imposed closures dramatically slowed the economy, led to higher borrowing which accelerated the increase in public debt. Although the risk of events like this makes it important to maintain fiscal space, they left the federal government with a considerably smaller margin for dealing with future challenges.

Notably, once the worst of the lockdowns subsided and economic activity resumed, the ensuing rebound helped partially restore some of that lost fiscal space. As businesses reopened and the initial supply chain limitations were overcome, consumer spending picked up, and labor markets began to adjust, faster economic growth helped increase revenues and eased pressure on deficits.4

Despite the groundwork for a strong economic recovery, legislation enacted during the Biden administration contributed to an expansion of federal spending, driving up inflation and borrowing needs as well as putting pressure on rising interest rates.5 Therefore, the considerable Biden-era deficit spending has slowed any gains that were being made to return fiscal space back to its pre-pandemic level.

Figure 1. Fiscal space as a percent of GDP, 2017 to 2024.

$420 Billion Needed by 2028 to Restore Fiscal Space

The fiscal health of the country is not as good as it was in 2017. This is a critical reason for why pro-growth reform is necessary including extending and building upon the TCJA, reducing burdensome regulation, and implementing other policies that ensure American workers and industry can thrive. However, this must also be paired with reforms to cut spending to keep inflation in check while also restoring the fiscal space lost during the Biden administration.

To restore the level of fiscal space held at the start of the Trump administration in 2017, policymakers must ensure that economic growth outpaces the rise in public debt. Suppose Congress and the incoming Trump administration were to adopt reforms that achieve an annual growth rate of 3 percent by 2028, as proposed by Treasury Secretary-Designee Scott Bessent. Under those circumstances, new debt over the next three years would need to remain below $6.5 trillion to return fiscal space to its earlier level.

The Congressional Budget Office currently projects that deficits will total about $5.5 trillion during the same period. This indicates that Congress has some flexibility to extend the provisions of the Tax Cuts and Jobs Act (TCJA), provided that such extensions (together with other pro-growth measures like deregulation) boost economic growth. However, because extending the TCJA is expected to add roughly $300 to $500 billion in deficits each year, any extension will need to be paired with policies that reduce primary deficits by cutting spending by approximately $100 to $140 billion per year. Taken together, these steps would help restore the fiscal space last seen in 2017.

Under the Congressional Budget Office’s baseline scenario, fiscal space will begin to diminish by the early 2030s even if interest rates remain relatively low and annual economic growth surpasses historical levels.6 Rising debt service costs, coupled with continued growth in major healthcare entitlements, will erode fiscal space faster than the economy can keep pace. This underscores the importance of bolstering fiscal space now, buying time to enact reforms that put the budget on a sustainable path. It also ensures that the government has ample room for a robust fiscal response should any unforeseen crisis arise.

Appendix

Methodology and Data

The estimates of the fiscal limit in this paper follows the approach proposed by Ghosh et al. (2013), who developed a framework to estimate the maximum level of public debt a government can sustain before it faces difficulties in servicing its obligations.7 Using the fiscal limit, we can then identify fiscal space which is the gap between a country’s current debt level and the estimated fiscal limit.

Ghosh et al. (2013) suggests that a government’s primary balance (i.e., total revenue minus non-interest expenditures) reacts non-linearly to changes in the debt-to-GDP ratio. In the early stages of the debt build-up, governments often react to rising debt levels by increasing their primary surplus to counteract growing debt. However, past a certain threshold, a phenomenon sometimes referred to as “fiscal fatigue” may emerge. This means that once debt becomes too large, policy actions that would ordinarily improve the balance (such as raising taxes or cutting expenditures) become difficult, causing the primary balance to weaken rather than strengthen.

To calculate the fiscal limit (and fiscal space), I first estimate the fiscal reaction function. The fiscal reaction function measures how the primary surplus (revenues minus non-interest spending, as a percentage of GDP) responds to rising debt. Empirically, a government that increases its surplus as debt rises can stabilize debt levels. However, if the government’s willingness or ability to run large surpluses fades at higher debt levels (sometimes called fiscal fatigue) then a limit on sustainable debt emerges.

From the estimated fiscal reaction function, it is possible to find the debt level at which the slope of the primary balance response turns negative (i.e., the fiscal limit). Once this point is reached, any further increase in debt would lead to a decline in the primary balance, rendering the debt path unsustainable. By estimating where this limit appears, we can also measure how much “fiscal space” remains before the risk of fiscal stress becomes significant. The gap between the current debt level and this estimated debt limit is the measure of fiscal space.

Data Used to Estimate the Fiscal Reaction Function, the Fiscal Limit, and Fiscal Space

The fiscal reaction function estimates the primary balance (as a percentage of GDP) in period t, as a function of the debt-to-GDP ratio in period t – 1, a quadratic term of debt-to-GDP in period t – 1 (to allow for fiscal fatigue), and a series of control variables. The historical primary balance and debt-to-GDP ratios are from the Congressional Budget Office. Control variables include the output gap, inflation, imports-to-GDP, oil price, ratio of the 15-to-64-year-old people (i.e., working age population) to the total population, and a variable indicating the years in which there was a statutory limit on discretionary spending. Estimates of GDP are from the Bureau of Economic Analysis. The real neutral rate of interest and economic growth are based on the Holston-Laubach-Williams (2017) approach and produced by the Federal Reserve Bank of New York.8 Values of marketable debt are from the Federal Reserve Bank of Dallas.

Table A1. Fiscal reaction function for the United States

Note: ***, **, * denotes significance at 1%, 5%, and 10% levels.

Table A1 shows the estimates of the fiscal reaction function for difference periods. It is also worth noting that the results are somewhat sensitive to the choice of data period. The fiscal reaction function used to produce the estimates above uses data covering the 1990 to 2023 period where there has been much higher debt than in the past. Including historical data going back to 1970, however, shifts the model’s estimates of the debt limit considerably. Different time horizons and policy environments can alter both the slope and the shape of the fiscal reaction function, suggesting that a one-size-fits-all threshold may not apply under all conditions. That said, the fiscal fatigue function captured in the lagged debt squared term is consistent over time and statistically significant for most sample periods.