How Interest on the National Debt Affects You

5 Ways to Reduce It

interest on the national debt will get harder to push
The interest on the national debt will get harder to push as the years roll on. Photo: bubaone/Getty Images

Definition: The interest on the national debt is how much the federal government must pay on outstanding public debt each year. The current interest on the debt is $266 billion. That's from the federal budget for fiscal year 2017 (October 1, 2016, through September 30, 2017).

The public debt is $14.7 trillion. That's debt owed to individuals, businesses, and foreign central banks. Most (95 percent) is Treasury bills, notes, and bonds.

 The remaining 4 percent 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. See Who Owns the U.S. Debt?

The interest on the debt consumes 6.5 percent of the U.S. federal budget. That makes it the fourth largest budget item. The four largest are Social Security benefits ($948 billion), military spending ($773.5 billion), Medicare ($592 billion), and Medicaid ($385 billion).

How Is It Calculated?

The interest on the debt is calculated by multiplying the face value of outstanding bills, notes, and bonds times their interest rates. 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 need a higher return to lend their money for a longer 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, then the interest rates will be low.

When there isn't much demand, the government has to pay a higher interest rate to sell all its bonds. Compare these changes in recent Treasury yield curves.

As you can see, 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 - 2026)

The interest on the debt was $253 billion in 2008. It consumed 8.5 percent of the FY 2008 federal budget. Since then, it's remained around $225 billion. That's despite the fact that the public debt has nearly tripled. It grew from $5.8 trillion in 2008 to $14.7 trillion in 2017. That's because public spending skyrocketed and revenue plummeted. To find out why, see Debt by President.

The interest on the debt declined to $187 billion in 2009 because interest rates fell. The yield on the 10-year Treasury note is given in the table below as an example. Rates fell by half,  from 3.7 percent in 2008 to 1.8 percent in 2012. They remained below 3 percent until 2017, due to strong demand for U.S. Treasurys. 

As a result, the interest on the debt only consumed 5.3 percent of the FY 2009 budget, even though the debt rose to $7.5 trillion.

From 2010 to 2016, it remained below $250 billion even though the debt almost doubled. 

Interest rates are projected to rise above 3 percent in 2018, according to the Office of the Management and Budget. They are expected to increase to nearly 4 percent by 2020. By then, the interest on the debt will almost double, to $474 billion. It will consume almost 9.7 percent of the budget. By 2026, the interest on the debt will be $787 billion, and take up 12.2 percent of the budget. 

That means the government will spend more on interest than on national defense by 2021. The following year, it will surpass all other discretionary spending. That's everything except the mandatory budget, which includes Social Security, Medicare, and Medicaid benefits. (Source: "The Legacy of Debt," The Wall Street Journal, February 5, 2016.) 

Fiscal YearInterest on the Debt Interest Rate on 10-Year TreasuryPublic DebtPercent of Budget
2008 $2533.7%$5,8038.5%
2009$1873.3%$7,5455.3%
2010$1963.2%$9,0195.7%
2011$2302.8%$10,1286.4%
2012$2201.8%$11,2816.2%
2013 $2212.4%$11,9836.4%
2014$2292.5%$12,7806.5%
2015$2232.1%$13,1176.0%
2016$2332.0%$14,1286.1%
2017$2662.8%$14,7006.5%
2018$3333.3%$15,1357.7%
2019$4073.6%$15,6688.8%
2020$4743.8%$16,1989.7%
2021$5293.9%$16,74710.3%
2022$5823.9%$17,39910.7%
2023$6343.9%$18,06611.3%
2024$6814.0%$18,71511.7%
2025$7304.0%$19,45311.9%
2026$7874.0%$20,26112.2%

(Source: "Table S-5. Mid-Session Review Fiscal Year 2017," Office of Management and Budget, July 15, 2016. Table 2. Economic Assumptions. Table S-1. Table S-4. Table S-5. Table S-12. "Historical Tables," Office of Management and Budget.)

Causes

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. For more, see How Does the Deficit Affect the Debt?

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. See How Much Does the United States Owe China?

Third, politicians get elected for creating jobs and growing the economy. They lose elections when unemployment and taxes increase. As a result, Congress has little incentive to reduce the deficit.

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 70 percent. That's because GDP measures a country's entire economic output, called Gross Domestic Product. 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.

It was a foolish attempt to limit government spending. Why? Because the Constitution gave Congress the ultimate authority to spend. Congress developed a budget process that's worked for years. Those Congressmen ignored the process, and 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. It's like driving with the emergency brake on. 

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

5 Ways to Reduce the Interest on the Debt

The most painless way to reduce the interest on the debt is to lower interest rates. That won't happen as long as the economy improves. 

The second 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. 

A fourth way is to cut spending. That will anger whomever is getting his or her 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 percent. Congress' reluctance to raise taxes then led to the 2013 fiscal cliff crisis.

A fifth way is to focus on activities that create the most jobs and maximize economic growth. For example, tax cuts create 10,779 jobs for every one billion dollars put back into the economy. That's better than defense spending, which just creates 8,555 jobs for every billion spent. But neither are as cost-effective as building mass transit. That creates 17,687 jobs for each billion spent. For more, see Unemployment Solutions.

The federal budget reveals that the government plans to do none of these. The Office of Management and Budget forecasts a deficit between $300 - $731 billion a year through FY 2026. 

President-elect Trump promised to reduce the deficit. He's named to be his budget director. Trump has criticized spending on Air Force One and the F-35 fighter jet. He must present the FY 2018 budget to Congress in February 2017. That will show exactly how he will reduce the deficit. He has also said he would default on the debt. That would be disastrous, as it would destroy confidence among Treasury bond holders. A U.S. debt default would send the interest on the debt skyrocketing. It could also lead to a dollar collapse. That's because the value of the U.S. dollar is tied to the value of U.S. Treasurys.

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.