The Consequences of Interest Costs on U.S. Debt

Over the next 30 years, the fastest growing category of government spending is projected to be interest on the national debt.  That means the government will be shelling out hundreds of billions of additional dollars each year for interest payments.

The growth in interest costs presents a huge threat to the economy and to Americans’ economic future.  The long-term societal effects will be massive; it will be a painful reckoning when the bill comes due.

According to the Congressional Budget Office’s (CBO’s) 2022 Long-Term Budget Outlook, the cost of interest on the national debt will surpass defense spending in 2029; Medicaid, Medicare and Child Health Insurance in 2046; and Social Security in 2048.

The CBO projected that annual interest costs paid to holders of Treasury securities would total $399 billion in 2022 and nearly triple over the coming decade to $1.2 trillion, growing from 1.6 percent of gross domestic product (GDP) to 3.3 percent in 2032, which would be the highest level ever.

If the Federal Reserve raises interest rates by larger amounts than the CBO has projected, costs may rise even faster than anticipated.  Still further, interest costs are on track to become the federal government’s single largest expenditure in 2054.  By then, interest costs will account for almost 40 percent of tax revenue and become the largest federal expenditure.

Rising interest payments are the result of escalating interest rates and debt levels that have risen like the blade of a hockey stick.  Treasury yields have surged with inflation running hot and the Federal Reserve in an aggressive tightening mode, while the national debt has grown by some $6 trillion since the pandemic began.  Pandemic-driven fiscal and monetary policies changed the debt situation considerably and for the worse.

The latest data show inflation at an 8.5 percent annual rate.  It is reasonable to expect the Fed to keep tightening over a sustained period, trying to reduce aggregate demand, relieve pressure on consumer prices and produce a hoped-for soft landing.  In 2017, the national debt was $20 trillion; now it is approaching $30 trillion.  Ten-year Treasury yields have climbed close to 3 percent, double what they were last December.

Increasing debt and high interest rates can crowd out important federal budget priorities and lead to a vicious cycle of even more debt, deficits, and interest payments.  This means the government will be paying hundreds of billions dollars more each year on interest payments on top of other fixed costs that are also growing, such as health and retirement provisions for an aging population.  This enhances the risk of a fiscal crisis.

As for those who hold on to the hope that folks in Washington will develop a long-term strategy to deal with the debt pile and deficits, it is likely time to label that as wishful thinking.

Congresses and presidents of both parties have long avoided making hard choices about the federal budget and failed to put it on a sustainable path.

In line with time-honored tradition, they prefer to just pop into the national arboretum of magical money trees and grab what they want.  The phrase “often wrong, but never in doubt” is only a slight exaggeration when it comes to their behavior.  The present commands their attention.  The few lawmakers raising issues about the debt, deficits, and rising interest costs are an endangered species.

Of course, crises can provide the necessary cover to make tough, hard decisions. As Stanford Professor Paul Romer said in 2004, a crisis is a terrible thing to waste – a sentiment later echoed by former White House Chief of Staff Rahm Emanuel.  Let’s hope the U.S. doesn’t waste this one.