Net interest payments exceeded Pentagon spending on military programs for the first time and accounted for about 18% of federal revenues, nearly double what it was two years ago.
In the fiscal year that just ended, the U.S. debt interest cost burden climbed to its highest level since the 1990s, further increasing the risk that fiscal concerns will limit the policy options of the next government in Washington.
The U.S. Treasury Department spent $882 billion on net interest payments in the fiscal year ending in September — about $2.4 billion a day — the equivalent of 3.06% of gross domestic product, the highest share since 1996, according to data released Friday by the Treasury Department.
Historically high U.S. budget deficits have caused total outstanding debt to soar in recent years, a big reason for the increase in interest payments. These deficits reflect steady increases in Social Security and Medicare spending, as well as extraordinary spending unleashed to combat the coronavirus pandemic and the constraints on revenues from the 2017 sweeping tax cuts. Another big driver is a surge in interest rates driven by inflation.
“The higher the interest costs, the more politically salient these issues become,” said Wendy Edelberg, director of the Brookings Institution’s Hamilton Project. “It makes it more likely that politicians will recognize that financing our spending priorities through borrowing is not without cost.”
While neither former President Trump nor Vice President Harris made deficit reduction a centerpiece of their campaigns, the debt issue still looms over the next administration. With Congress deeply divided, it only takes a few or perhaps just one deficit-wary lawmaker to block tax and spending plans.
This situation has already occurred under the outgoing Biden administration, when then-Democrat Joe Manchin forced the White House to scale back its favored spending programs as the price of passing signature legislative packages in 2021 and 2022.
Even if Republicans control both chambers of Congress and Trump wins the White House, the majority advantage is likely to shrink, which would give GOP fiscal hawks the ability to demand changes to the across-the-board tax cuts.
“It would be amazing if the result of the tax debate next year was that a large group of policymakers looked at our debt trajectory and decided to make it worse,” said Edelberg, a former chief economist at the Congressional Budget Office (CBO).
Net interest payments for the first time exceeded what the Defense Department spent on military programs, according to Treasury and CBO data. Net interest payments, which account for about 18% of federal revenues, are nearly double what they were two years ago.
The Fed’s shift to lower interest rates has provided some relief to the Treasury. The weighted average interest on outstanding U.S. debt was 3.32% at the end of September, the first monthly decline in nearly three years.
Even so, the scale of the interest bill is now so large that it alone adds to the public’s overall debt burden, which now stands at $27.7 trillion, or nearly 100% of GDP. Debt servicing was one of the fastest-growing parts of the budget last year. Interest payments can also crowd out private investment, hurting economic growth.
The nonpartisan CBO estimates that for every dollar of deficit-financed spending, private investment falls by 33 cents.
“From every perspective, the interest costs that add to the debt and lead to other economic consequences are a problem for our economy,” said Shai Akabas, executive director of the Bipartisan Policy Center’s Economic Policy Program.
Treasury Secretary Janet Yellen downplayed concerns. She said the key indicator for assessing U.S. fiscal sustainability is the ratio of interest payments adjusted for inflation to GDP. That ratio has risen over the past year, but the White House sees it stabilizing around 1.3% over the next decade. Yellen has said it is important to stay below 2%, a level some consider a key threshold for sustainability.
However, the White House forecast assumes that revenue-raising measures proposed by the outgoing Biden administration are passed. Harris has also called for higher taxes on the wealthiest Americans and businesses. Trump, for his part, said the key to addressing the fiscal outlook is further tax cuts, which he believes would boost economic growth and offset the hit to the government's bottom line.
Most economists believe that the debt will continue to climb no matter which candidate wins. The Committee for a Responsible Federal Budget estimates that Harris' economic plan would increase the debt by $3.5 trillion over a decade, while Trump's plan would cause the debt to soar by $7.5 trillion.
In addition to the election outcome, the magnitude of the Fed’s rate cuts will also affect the fiscal outlook. After policymakers start raising rates in March 2022, the Treasury’s interest bill will quickly reflect the size of the rate hikes, while rate cuts may take more time to reduce the government’s borrowing costs.
That’s partly because some of the U.S. debt maturing in the next few years carries particularly low interest rates, which predates the Fed’s tightening cycle. Many of these securities will be replaced by more expensive U.S. Treasuries.
The same could be true in the coming years — especially if the Fed stops cutting rates while they remain above pre-pandemic levels. The Fed’s short-term benchmark rate averaged less than 0.75% in the decade through 2019, and policymakers in September projected it would stabilize around 2.9%.
At the same time, as the U.S. population ages, costs associated with Social Security and Medicare will continue to rise, creating excessive budget deficits for decades unless reforms are enacted.
That pressure, and politicians’ aversion to changing popular programs, has put pressure on the remaining area of federal spending: discretionary spending.
In the 1960s, discretionary spending accounted for about 70% of total federal spending, but now it accounts for just 30%, according to an analysis by Torsten Slok, chief economist at Apollo Global Management.
For now, investors are showing little sign of concern about the U.S. fiscal challenges as the Federal Reserve’s easing cycle and concerns about a weak job market continue to support demand for Treasuries. But if that happens, it could have a decisive impact on Washington, said Gary Schlossberg, global strategist at Wells Fargo Investment Institute.
“The landscape has changed,” Schlossberg said. “Before, we had more freedom — interest rates were low. You could borrow money and the interest payments weren’t high, but that’s obviously not the case now.”
