The federal government funds deficit spending by borrowing. When tax revenue falls short of what Congress has authorized to spend, the Department of the Treasury covers the gap by selling debt securities backed by the full faith and credit of the United States, and by issuing special securities to federal trust funds that are running surpluses. For fiscal year 2026, the Congressional Budget Office projects a deficit of roughly $1.9 trillion, about 5.8 percent of GDP, and every dollar of it has to be financed this way.1Congressional Budget Office. The Budget and Economic Outlook: 2026 to 2036 Total federal debt outstanding sits at about $38.9 trillion as of early 2026.2U.S. Treasury Fiscal Data. Understanding the National Debt
What the Treasury Sells
The borrowing takes the form of several distinct securities, each designed to appeal to a different kind of investor. Short-term Treasury Bills mature in 4, 8, 13, 17, 26, or 52 weeks and pay no coupon; the return is the difference between the discounted purchase price and the face value at maturity.3TreasuryDirect. Treasury Bills Treasury Notes run 2, 3, 5, 7, or 10 years and pay a fixed rate every six months.4TreasuryDirect. Treasury Notes Treasury Bonds carry 20- or 30-year terms with the same semiannual interest structure.5TreasuryDirect. Treasury Bonds
Two specialized instruments round out the mix. Treasury Inflation-Protected Securities adjust their principal up or down with the Consumer Price Index, preserving the investor’s purchasing power.6TreasuryDirect. TIPS Floating Rate Notes are two-year securities whose rate resets weekly against the most recent 13-week T-Bill auction, plus a fixed spread set when the FRN is first issued.7TreasuryDirect. Floating Rate Notes (FRNs)
Having a full menu of maturities lets the Treasury shift its borrowing toward whatever part of the yield curve is cheapest at the moment. Interest on all of these is taxable federally but exempt from state and local income tax.
How the Debt Gets Sold: The Auction
Treasury securities reach the market through regularly scheduled auctions governed by 31 C.F.R. Part 356.8eCFR. 31 CFR Part 356 – Sale and Issue of Marketable Book-Entry Treasury Bills, Notes, and Bonds Bidders come in through one of two doors.
A noncompetitive bidder agrees to accept whatever yield the auction sets and is guaranteed to receive the full amount requested, up to $5 million per auction.9U.S. Treasury Fiscal Data. Treasury Securities Auctions Data Most individual investors use this route.
A competitive bidder, usually a large financial institution, specifies the minimum yield it will accept. After noncompetitive bids are filled, the Treasury takes competitive bids from the lowest yield upward until the offering is fully subscribed. The highest yield accepted becomes the rate paid to every winning bidder. The cash raised at settlement flows into the Treasury’s operating account and pays whatever obligations are due.
Who Actually Lends the Money
The buyers fall into three groups.
Domestic Investors
Commercial banks, mutual funds, insurance companies, pension funds, and individual savers all hold Treasuries. Pension funds lean on long-dated Notes and Bonds to match payments owed to retirees. Because Treasuries are the deepest, most liquid asset in the world, banks and dealers also use them as collateral in day-to-day financial transactions, which keeps demand steady even when yields are modest.
Foreign Investors
Foreign governments and central banks hold Treasuries as foreign exchange reserves. As of late 2025, Japan was the largest foreign holder at roughly $1.2 trillion, followed by the United Kingdom and China. This overseas demand puts downward pressure on the interest rates the Treasury pays, though it can shift with exchange-rate policy or geopolitics abroad.
Federal Trust Funds
Not all the borrowing happens in public markets. About $7.6 trillion of the national debt is money the government owes to itself.10Joint Economic Committee. Monthly Debt Update When a program like Social Security collects more in payroll taxes than it pays out, the surplus is invested in special-issue Treasury securities that don’t trade on the open market.11Office of the Law Revision Counsel. 42 USC 401 – Trust Funds The Treasury spends the cash on current operations and hands the trust fund an interest-bearing IOU in return.
The Social Security trust funds held roughly $2.7 trillion in these securities at the end of 2024,12Social Security Administration. Trustees Report Summary and the Medicare Hospital Insurance Trust Fund is projected to hold about $252.8 billion in 2026.13CMS. 2025 Medicare Trustees Report When those securities eventually need to be redeemed to pay benefits, the Treasury has to produce the cash from tax revenue, new public borrowing, or spending cuts elsewhere. It’s real debt, just held internally.
Where the Federal Reserve Fits In
The Federal Reserve does not buy Treasury securities directly at auction. It operates in the secondary market, buying and selling previously issued Treasuries to manage the money supply and influence interest rates. As of March 2026, the Fed held approximately $4.35 trillion in Treasuries on its balance sheet.14Federal Reserve. Factors Affecting Reserve Balances – H.4.1
When the Fed buys Treasuries from banks, it pays with newly created reserves, expanding the money supply and lowering long-term rates. Lower rates make it cheaper for the Treasury to issue new debt. There’s also a partial refund built in: the Fed earns interest on its holdings, and after covering operating expenses it remits the profits back to the Treasury. That reduces the net cost of the debt the Fed holds, though it doesn’t eliminate it and carries inflationary risk if the balance sheet gets too large.
The Ceiling on Borrowing
Congress caps total federal debt at a level set in 31 U.S.C. ยง 3101, and periodically raises or suspends the ceiling by separate legislation.15Office of the Law Revision Counsel. 31 USC 3101 – Public Debt Limit The Fiscal Responsibility Act of 2023 suspended the limit through January 1, 2025, after which it snapped back to whatever level debt had reached.16Congressional Budget Office. Federal Debt and the Statutory Limit, March 2025
When the ceiling is hit and Congress has not acted, the Treasury deploys “extraordinary measures,” a set of accounting maneuvers that free up headroom without issuing new net debt. These include suspending certain federal retirement fund investments and pausing reinvestment of the Thrift Savings Plan’s G Fund.17Department of the Treasury. Description of the Extraordinary Measures They typically buy a few months. If the limit isn’t raised before they run out, the government faces a possible default, an outcome that has never occurred.
What the Borrowing Costs
Every outstanding security pays interest, and the bill has grown into one of the largest items in the budget. For fiscal year 2026, CBO projects net interest outlays of roughly $1.0 trillion, about 3.3 percent of GDP and a $69 billion increase from 2025.1Congressional Budget Office. The Budget and Economic Outlook: 2026 to 2036 Interest now consumes roughly 15 percent of all federal spending. About one of every seven federal dollars goes to bondholders rather than to programs.
The average interest rate on debt held by the public is estimated at 3.4 percent for 2026.1Congressional Budget Office. The Budget and Economic Outlook: 2026 to 2036 That rate blends older debt locked in at low rates with newer securities issued during the higher-rate stretch of recent years. As cheaper debt matures and rolls into new issuance, average borrowing costs continue climbing even if market rates hold flat.
The Risks of Financing Deficits This Way
Persistent borrowing at this scale carries real risks. Heavy government demand for credit competes with private borrowers for the same pool of savings, a dynamic economists call crowding out. When it happens, interest rates run higher than they otherwise would, and business investment in factories, housing, and equipment slows.
Investor confidence is the other pressure point. In May 2025, Moody’s downgraded the United States from Aaa to Aa1, citing more than a decade of rising debt and interest ratios well above those of other top-rated countries and the failure of successive administrations and Congress to agree on measures to reverse large annual deficits.18Moody’s Ratings. Moody’s Ratings Downgrades United States Ratings to Aa1 From Aaa With S&P having downgraded in 2011 and Fitch in 2023, the U.S. is no longer rated Aaa by any of the three major agencies.
The dollar’s reserve status, the depth of Treasury markets, and the size of the U.S. economy still provide substantial buffers. But CBO projects debt held by the public to rise from 101 percent of GDP in 2026 to 120 percent by 2036.1Congressional Budget Office. The Budget and Economic Outlook: 2026 to 2036 As the number climbs, more of each tax dollar is committed to interest before Congress makes any spending decision at all, and any spike in borrowing costs becomes harder to absorb.