October 2, 2014

The Right Budget Deal Could Help Curb Government’s Rising Interest Costs

Lawmakers struggling with the Fiscal 2014 budget will face an even tougher challenge funding the government in future years as interest payments rise to record levels, squeezing other parts of the budget and making it more difficult to quell rising deficits.

Although slow economic growth and Federal Reserve monetary policies have kept interest rates at record lows in recent years, the Congressional Budget Office (CBO) expects rates to rise steadily in the coming years, making interest payments the fastest growing part of the federal budget.

For Fiscal 2013, CBO estimates interest payments totaling $223 billion, or 1.3 percent of GDP. By 2023, interest payments are expected to climb to $823 billion, which is 3.1 percent of GDP -- a percentage that has only been exceeded once in the past 50 years. By 2038 the figure would increase to 4.9 percent.

Rising interest payments would make a larger share of revenue unavailable for spending on federal programs; to prevent the deficit from growing larger, rising interest payments would either crowd out spending on federal programs or cause taxes to go up.

Assuming Washington eventually navigates its immediate budget and debt limit difficulties, interest rates are expected to rise in the next few years due to an improving economy. Yet, if interest rates are even slightly higher than current projections over the next few years, it could add billions of dollars in federal interest payments.

Interest rates on 10-year Treasury notes, currently at 2.6 percent, are already higher than CBO projections. In its long-term fiscal outlook, CBO predicted that a .75 percent rise in interest rates would increase the debt-to-GDP ratio to 77 percent in 2023, compared to 71 percent without the rate increase. By 2038 the debt-to-GDP ratio would hit 132 percent, compared to 108 percent without the rate increase.

The risks associated with rising interest payments are significant. The solution is for Washington to agree on a long-term deficit-reduction plan that will reduce government borrowing and gradually decrease the size of the federal debt relative to the economy.