Interest on the National Debt and How It Affects You
Four Ways to Reduce It
The interest on the national debt is how much the federal government must pay on outstanding public debt each year. The interest on the debt is $479 billion. That's from the federal budget for fiscal year 2020 that runs from October 1, 2019, through September 30, 2020.
The public debt is $18.087 trillion, according to Table S-1 of the president's budget for FY 2020. That's debt owed to individuals, businesses, and foreign central banks. Over 90% is Treasury bills, notes, and bonds. The remaining debt instruments are TIPS, Savings Bonds, and other securities.
The government also owes the Social Security Trust Fund and other federal agencies. That's called intragovernmental debt. It's not included in the interest on the debt. That's because it's money the government owes itself. It explains why the American people own most of the U.S. debt. The interest on the debt consumes 10% of the FY 2020 U.S. federal budget.
How It Is Calculated
The interest on the debt is calculated by multiplying the face value of outstanding Treasurys times their interest rates. Treasury bills have short durations of one, three, and five months. Notes are sold in one, five, and 10-year durations. Bonds are for 15 and 30 years. The short-term debt has lower interest rates than the long-term debt. That's because investors don't demand as much of a return to lend their money for a shorter period of time.
The interest rate on each bill, note, or bond depends on when it was issued. Interest rates change over time, depending on the demand for U.S. Treasurys. When the demand is high, you can expect the interest rates will be low. When demand falls, the government has to pay a higher interest rate to sell all its bonds. Compare these changes in recent Treasury yield curves.
The interest on the debt is not simple to calculate. You can't simply multiply the total outstanding debt number by today's interest rate to get the right figure. But, in general, a large debt and a high interest rate will create a large interest rate payment.
Interest on the Debt by Year (2008 - 2027)
The interest on the debt was $253 billion in 2008. It consumed 8.5% of the FY 2008 federal budget. In 2009, it declined to $187 billion because interest rates fell. The yield on the 10-year Treasury note is given in the table below as an example.
As a result, the interest on the debt only consumed 5.3% of the FY 2009 budget, even though the public debt rose to $7.5 trillion. From 2009 to 2016, it remained below $250 billion even though the debt almost doubled. The debt grew because public spending skyrocketed and revenue plummeted. The recession is the reason why President Obama created the most debt of any president.
Interest on the 10-year Treasury remained below 3% until 2018 thanks to strong
demand for U.S. Treasurys. Interest rates are projected to rise above 3%
in 2019, according to the Office of Management and Budget. They are
expected to increase to 3.7% by 2026. By then, the interest on the debt will be
$762 billion, and take up 12.9% of the budget.
|Fiscal Year||Interest on the Debt||Interest Rate on 10-Year Treasury||Public Debt||Percent of Budget|
(Source for 2018 - 2026: "Tables S-1, S-4, S-9, FY 2020 Budget," Office of Management and Budget.)
Higher interest rates and a growing debt are the two main causes of the interest on the debt. But what causes them to rise? Interest rates increase when the economy is doing well. That's because investors have the confidence to buy riskier assets, such as stocks. There is less demand for bonds, so the interest rates must rise to attract buyers. The debt is the accumulation of each year's budget deficit. That happens each year spending is greater than revenue. A larger debt also affects the deficit, thanks to the higher interest payment.
Since Bill Clinton's administration, each president and Congress has planned to overspend. First, deficit spending stimulates the economy by putting money into the pockets of businesses and families. They purchase goods and hire workers, creating a robust economy. For that reason, government spending is a component of GDP. Second, countries such as China and Japan lend America the money to buy their products. As a result, the United States owes China 18% of all debt owed to foreign countries as of September 2018.
How It Affects You
The interest on the debt immediately reduces the money available for other spending programs. As it increases over the next decade, advocates of those benefits will call for a reduction in spending in other areas.
In the long-term, a growing debt burden becomes a big problem for everyone. That's called the tipping point. The World Bank says a country reaches that point when the debt-to-GDP ratio approaches or exceeds 77%. That's because gross domestic product measures a country's entire economic output. When the debt is greater than the entire country's production, lenders worry whether the country will repay them. In fact, they did become concerned in 2011 and 2013. That's when tea party Republicans in Congress threatened to default on the U.S. debt.
There are some who would say it was a foolish attempt to limit government spending. Why? Because the Constitution gives Congress the ultimate authority to spend and by ignoring their budget process may have needlessly worried the nation's lenders.
Once lenders become concerned, they demand higher interest rates. Buyers of U.S. Treasurys appreciate the security of knowing they will be repaid. They'll want compensation for an increasing risk they won't be repaid. Diminished demand for U.S. Treasurys would further increase interest rates. That slows economic growth.
Lower demand for Treasurys also puts downward pressure on the dollar. That's because the dollar's value is tied to that of Treasury securities. As the dollar declines, foreign holders get paid back in currency that is worth less. That further decreases demand.
The rising interest on the debt worsens the U.S. debt crisis. Over the next 20 years, the Social Security Trust Fund won't have enough to cover the retirement benefits promised to seniors. Congress would find ways to reduce benefits rather than raise taxes. For example, some are talking about privatizing Social Security.
Four Ways to Reduce the Interest on the Debt
1. The most painless way to reduce the interest on the debt is to lower interest rates. That isn't likely to happen as long as the economy improves.
2. Another way is to increase tax revenues. That will lower the deficit and add less to the debt. Tax increases are an immediate solution, but they also slow economic growth. In addition, voters reject politicians who raise taxes. A fast-growing economy will also boost tax revenues.
3. A third way is to cut spending. That will anger whomever is getting their benefits reduced. Although politicians often talk about it, they usually want to cut someone else's spending. That's why Congress wouldn't adopt the bi-partisan Simpson-Bowles plan in 2010. Lawmakers passed the 2011 Budget Control Act to force themselves to come up with a solution. When they couldn't, sequestration cut all discretionary spending by 10%. Congress' reluctance to raise taxes then led to the 2013 fiscal cliff crisis.
4. Another less direct way is to shift federal spending to activities that create the most jobs and maximize economic growth. For example, a 2011 University of Massachusetts/Amherst study found that tax cuts create 15,100 jobs for every one billion dollars put back into the economy. That's better than defense spending, which just creates 11,200 jobs for every billion spent. But neither are as cost-effective as education spending. That creates 26,700 jobs for each billion spent. Spending on education appears to be one of the best unemployment solutions available.
Why You Should You Be Concerned
Ultimately, voters must pressure the president and Congress to reduce the deficit. That will slow the increase in the debt. The interest on the debt will still rise along with interest rates, but at a slower rate. Otherwise, the interest on the nation's debt will consume the budget and the standard of living for future generations.