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 $378 billion. That's from the federal budget for fiscal year (FY) 2021 that runs from October 1, 2020, through September 30, 2021.
The public debt is just under $27 trillion in the third quarter of 2020. That's debt owed to individuals, businesses, and foreign central banks. The debt is held in the form of Treasury bills, notes, and bonds, as well as 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 public debt is owned by the American people, either through individual investors, the Federal Reserve, or state and local governments.
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 ranging from a few days to 52 weeks. Notes are sold in two-, three-, five-, seven-, and 10-year durations. Bonds are for 15 and 30 years. 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 issued during a high-interest rate environment will create a large interest payment.
Interest on the Debt by Year (2008-2030)
The interest on the debt was $253 billion in 2008. It consumed 8.5% of the FY 2008 federal budget. In 2010, it declined to $197 billion because interest rates fell. As a result, even though public debt increased, its interest payments as a percentage of GDP increased by less than 0.01%.
From 2009 to 2015, it remained below $250 billion even though the national debt almost doubled as public spending skyrocketed and revenue plummeted. Even though President Obama created significant debt, the costs of the debt didn't increase as substantially as the debt levels themselves.
The most recent fiscal year budget does not take into account increased U.S. spending to offset the effects of the COVID-19 pandemic.
The yield on the 10-year Treasury note is expected to remain below 3% until 2024, thanks to strong demand for U.S. Treasurys. By 2026, the interest on the debt will be $543 billion.
Take a look at the chart below to see debt and interest cost trends in recent years, as well as projections into the near future. This information comes from the Fiscal Year 2021 budget proposal. The interest information can be found in Table S-4, including the percent of budget. The 10-year interest rate figures used in these calculations can be found in Table S-9. Public debt is found in Table S-1.
|Fiscal Year||Interest on the Debt (in billions)||Interest Rate on 10-Year Treasury||Public Debt (in billions)||Percent of 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.
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 third quarter of 2020, the U.S. debt-to-GDP ratio was 127%.
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 a currency that is worth less than they anticipated when they originally lent the money. 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.
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 dependent on other economic factors. As the COVID-19 pandemic hit the U.S. in 2020, the Fed dropped interest rates as low as possible.
- 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. Voters also often reject politicians who raise taxes. A fast-growing economy will also boost tax revenues.
- Cut spending: This strategy will anger whoever is getting their benefits reduced. Although politicians often talk about cutting spending, they usually want to cut someone else's spending. If they cut their own spending or spending that impacts constituents, they could face a political cost.
- 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.