Set to overtake spending by the Department of Defense, the net interest on the national debt is currently the US government's fastest-growing major expense. According to the Congressional Budget Office (CBO), interest costs are on track to next year reach $390 billion, 50% higher than last year’s total. Interest payments will reach $570 billion in 2021, and by 2023 will surpass $700 billion, an amount roughly equivalent to the entire defense budget.
Interest costs are rising both as deficit spending raises the overall debt burden and as higher interest rates make the federal debt more expensive. These dual trends are not expected to reverse in the near term; further rise in interest payments is likely ahead.
For nearly a decade since the Great Recession, low interest rates have encouraged borrowing across the board and muted the costs of increased deficit spending. The Federal Reserve is now raising the target rate, which drives all other domestic interest rates. The current debt burden is nearly $16 trillion. While the pace of rate increases is gradual, even a small increase will yield a sizeable rise in borrowing costs.
Furthermore, larger budget deficits – due to increased spending and diminished federal cash receipts – are adding to the overall debt burden. The federal budget deficit is expected to reach nearly $1 trillion in 2019; we may be gaining some economic benefit now while adding to the future problem – making interest payments and eventually retiring the debt. The CBO estimates that the latest round of tax cuts will add an average of $250 billion to the deficit every year from 2019 to 2024. The current proposal to make the tax cuts permanent rather than allowing some to expire in 2025 would further fuel the deficit.
The factors outlined above suggest that interest costs will rise in the future. Interest payments accounted for 6.6% of overall government spending last year but will account for 13.0% of the federal budget in a decade, according to CBO estimates. Higher mandatory interest payments must come with a cost: Restricted government spending in other areas, higher taxes, or even more borrowing.
Lauren Saidel-Baker, CFA
Economist