The Real Fiscal Cliff: Interest Payments on the National Debt

Aug 18, 2014

National Debt Clock.jpg

Federal policymakers are prone to hyperbole. One recent incident involved the so-called “Fiscal Cliff” where expiring tax cuts and spending cuts would conspire to send the economy into a recession. Of course, this had to be avoided at all costs so some taxes were increased and spending cuts reduced. Phew, the end of the world narrowly avoided.

Well, not quite. Federal policymakers are also prone to extreme myopia. Had nothing happened to avert the Fiscal Cliff, the economy may have had some heartburn for a few quarters, but life would have gone on. All the while, a much bigger Fiscal Cliff looms over the horizon—a decade long horizon.

Unfortunately, a decade to politicians might as well be a life-time. That’s another 5 elections for members of the U.S. House and another term and a half for members of the U.S. Senate. The current crop of politicians could be long gone before the Real Fiscal Cliff arrives. So it goes unreported and unnoticed by most.

So what is this Real Fiscal Cliff? It is the growing interest payments on the growing national debt. Imagine a household that is using their credit card to pay for everyday expenses. Then one day, this household discovers that they are actually borrowing just to pay the interest on their credit card debt. They are trapped and unless they significantly grow their income there is only one other way out—bankruptcy.

This is the very scenario that Uncle Sam is facing within the decade. Here is how we have gotten into this mess. According to the most recent budget projection by the Congressional Budget Office made in April, 2014 (pdf), Uncle Sam is simply unable to contain his profligate spending with red ink as far as the eye can see. Between 2014 and 2024, the federal deficit will grow by 49 percent to $793 billion from $531 billion.

As a result, the size of the national debt will continue to grow as well. As shown in Chart 1, between 2014 and 2024 the national debt will grow by 64 percent to $20.1 trillion from $12.7 trillion. In fact, the national debt will even be growing faster than the economy going from 73.8 percent of Gross Domestic Product (GDP) in 2014 to 78.1 percent of GDP in 2024.

Chart 1 Federal Debt Soars 2013 to 2024.jpg

The growth in the national debt combined with projected increases in the interest rate means that the interest paid on the national debt is set to explode. Even the CBO warns:

“CBO expects two factors to boost the government’s interest payments sharply during the coming decade. The first is a rise in interest rates as the economy strengthens. Between calendar years 2014 and 2024, by CBO’s expectations, the average interest rate on three-month Treasury bills will rise from 0.2 percent to 3.7 percent, and the average rate on 10-year Treasury notes will rise from 3.1 percent to 5.0 percent.”

“At the same time, debt held by the public is projected to increase significantly under current law. Debt held by the public consists mostly of securities that the Treasury issues to raise cash to fund the federal government’s activities and to pay off its maturing liabilities. The net amount that the Treasury borrows by selling those securities (the amounts that are sold minus the amounts that have matured) is influenced primarily by the annual budget deficit. In addition, the Treasury borrows to provide financing for student loans and other credit programs; CBO projects that such additional borrowing, often called ‘other means of financing,’ will average $59 billion per year during the 2014-2024 period. After accounting for all of the government’s borrowing needs, CBO projects that, under current law, debt held by the public will rise from $12.7 trillion at the end of 2013 to $20.9 trillion at the end of 2024. Relative to the size of the economy, it will stay between 72 percent and 74 percent of GDP through 2020 but then rise steadily, reaching 78 percent of GDP at the end of 2024.”

“The rising interest rates and federal debt are expected to raise net interest payments from $227 billion in 2014, or 1.3 percent of GDP, to $876 billion in 2024, or 3.3 percent—a level that has not been reached in the post-World War II era.”

Wow, let that last sentence sink in for a moment . . . “a level that has not been reached in the post-World War II era.” Chart 2 shows what the CBO just said.

Chart 2 Interest Payments on Federal Debt Soars 2013 to 2024.jpg

However, the CBO does not go far enough in their analysis. They fail to point out that, as shown in Chart 3, interest payment on the national debt will exceed the federal deficit for the first time in 2024. This is the case of the household we just discussed above. This puts Uncle Sam in a precarious position—either raise income (which means higher taxes for you and me) or declare bankruptcy. Neither option is pretty.

Chart 3 Interest Payments Exceed Budget Deficit in 2024 2013 to 2024.jpg

But wait, there’s more! The CBO also neglects to mention what happens if interest rates go even higher than they predict. The final chart, put together by Veronique de Rugy at the Mercatus Center, shows how interest payments would be significantly higher with higher interest rates. In the worst case scenario, if we went back to double-digit interest rates of the 1980s, then interest payment on the debt would soar to over $2 trillion per year in the 2020s.

Interest Costs May Exceed Expectations.jpg

This, folks, is the Real Fiscal Cliff.

And the worst case scenario is more likely than not. Why? The marketplace will take notice of the fact that interest payments are becoming a greater and greater share of the annual budget deficit. As such, the chances of economy crushing tax hikes or default will grow as well. The market will demand compensation in the form of higher interest rates on government securities. Higher interest rates lead to bigger budget deficits leading to higher interest rates . . . well, you can see where this is going.

The only hope we have of stopping this runaway train is to cut federal spending NOW. Not tomorrow, next week or next year, but right NOW. And cut until the budget deficit becomes a sustainable budget surplus without tax increases. Sure the economy may slow down and may even go into a recession. That pales in comparison to what will happen when Uncle Sam hits the interest payment wall in 2024.

Stay tuned to Key Policy Data as we will update this doomsday analysis whenever CBO releases new projections. The best way to do so is to subscribe to our email list which you can do in the sidebar. Tick, tock, tick, tock . . .

J. Scott Moody

Scott has nearly 20 years of experience as a public policy economist. He is the author, co-author and editor of over 180 studies and books. His professional experience also includes positions at the American Conservative Union Foundation, Granite Institute, Federalism In Action, Maine Heritage Policy Center, Tax Foundation, and Heritage Foundation.

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