Interest on the National Debt and How It Affects You
Plus 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% comes from Treasury bills, notes, and bonds. The remaining debt instruments are Treasury Inflation Protected Securities (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 part of the public debt and doesn't impact the interest on the debt. That's because it's money the government owes itself. The majority of government debt is public—debt the American people own. The interest on that 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 Treasuries 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 long-term debt because investors don't demand as much of a return when lending their money for a shorter period.
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. Treasuries. 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. This is why the Treasury yield curve changes over time.
The interest on the U.S. national debt is not easy 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 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 national debt almost doubled as public spending skyrocketed and revenue plummeted. The recession led President Obama to create the most debt of any president.
Interest on the 10-year Treasury remained below 3% until 2018, thanks to strong demand for U.S. Treasuries. Interest rates were projected to rise above 3% in 2019 but were lagging below 2% at the end of September as economic outlook dampened. 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 (in billions)||Interest Rate on 10-Year Treasury||Public Debt (in bilions)||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 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. 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. There are a few reasons for this strategy. 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, the U.S. can rely on countries such as China and Japan to lend America the money to buy their products. As a result, the United States owes China 27% of all debt owed to foreign countries as of May 2019.
Finally, 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 national debt immediately reduces the money available for other spending programs. As it increases over the next decade, advocates of certain 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. The World Bank says a country reaches a tipping point when the debt-to-GDP ratio approaches or exceeds 77%. In the second quarter of 2019, the U.S. debt-to-GDP ratio was 103.2%.
Gross domestic product measures a country's entire economic output. When a country's debt is close to or greater than the entire country's production, lenders worry whether the country will repay them. In fact, lenders did become concerned in 2011 and 2013, when tea party Republicans in Congress threatened to default on the U.S. debt.
Once lenders become concerned, they demand higher interest rates. Buyers of U.S. Treasuries appreciate the security of knowing they will be repaid. They'll want compensation for the increased risk. Diminished demand for U.S. Treasuries would further increase interest rates, which slows economic growth.
Lower demand for Treasuries 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 and creates a vicious cycle.
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 could find ways to reduce benefits or otherwise change the program rather than raise taxes. For example, some are talking about privatizing Social Security.
Four Ways to Reduce the Interest on the Debt
Congress has a few options when it comes to reducing the interest owed on the national debt.
- Lower interest rates: This is the most painless way to lower interest paid. However, it's heavily depended on other economic factors. In July 2019, the federal reserve made its first rate decrease since the financial crisis.
- 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. Besides, voters reject politicians who raise taxes. A fast-growing economy will also boost tax revenues.
- 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 bipartisan 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%.
- Shift federal spending: Rather than cutting, congress can shift 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 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 is as cost-effective as education spending, which creates 26,700 jobs for each billion spent. Spending on education appears to be one of the best unemployment solutions available.
Why You Should Be Concerned
President Trump has promised to reduce the deficit. He criticized spending on Air Force One and the F-35 fighter jet. Thus far, his budgets have increased the deficit and the debt, although the deficit is projected to drop in 2024.
Ultimately, voters must pressure the president and Congress to reduce the deficit. That will slow the increase in the national 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.