Mounting Interest Costs Will Shrink Federal Revenues and Harm the Economy

Mounting Interest Costs Will Shrink Federal Revenues and Harm the Economy

iStockphoto/The Fiscal Times

The mounting interest costs that the federal government pays on the public debt is rapidly eating away at government resources and could greatly restrict what future government leaders will be able to do in terms of spending and tax policy, according to a new Congressional Budget Office long-term budget outlook.

While interest costs on government borrowing typically receive scant public attention, the CBO says that they will eventually exceed all discretionary spending on domestic programs and agencies, other than entitlements like Social Security, Medicare and Medicaid.

Related: Prospects Dim for Deficit Control as Trump Drives for Defense Buildup

The bigger new out of the CBO report released Thursday, of course, is that publicly held debt is at its highest level since 1950 and is projected to rise to a startling 150 percent of Gross Domestic Product by 2047 absent any dramatic shift in federal spending and tax policy.

Debt Held by Public - Projected Through 2047

With President Trump and congressional Republican leaders expected to press for major increases in defense and national security spending and deep tax cuts totaling trillions of dollars, government spending is all but certain to continue to outstrip revenues over the coming decades.

Even under current policies, revenues will grow from 17.8 percent of GDP in 2017 to 19 percent in 2047, while projected spending will surge from 20.7 percent of GDP this year to 29.4 percent in 2047. That will perpetuate a yawning structural revenue gap that has forced the Treasury to accelerate its borrowing and will push the gross national debt to an historic $20 trillion level this year.

As a line item in the federal budget, interest payments on the debt sometimes gets short shrift or even ignored in congressional debates on budget and tax issues. Yet, in 2015 interest on the debt consumed six percent of the entire $3.7 trillion government budget and is on track to eventually exceed spending for most domestic programs and agencies, including law enforcement and social safety net programs like food stamps, transportation and housing.

Related: Clock Starts Ticking on Possible Treasury Debt Ceiling Crisis

“Rising interest costs is responsible for half of all spending growth over the next three decades, and it’s not only driving up debt levels but crowding out investments in education, infrastructure, and national defense in the process,” said Marc Goldwein, senior vice president and policy director for the Committee for a Responsible Federal Budget, a prominent budget watchdog.

Indeed, if the current pattern of mounting debts and rising interest rates persist, interest on the debt will become the third largest category of the budget by 2028, behind only Social Security and Medicare coverage for the fast-growing population of seniors and retirees.

CBO Interest Rates Projection

The combination of a strengthening economy, the Federal Reserve’s decision March 15 to raise interest rates for the second time in three months after keeping them at historic lows since the 2008 financial crisis, and rampant borrowing by the Treasury to keep up with runaway spending have all conspired to boost the government’s interest costs to well in excess of $230 billion annually.

The government is stuck on a fiscal treadmill, struggling to keep up with interest payments on the debt even as its budget and tax policies put it farther and farther behind. The Treasury regularly must borrow from China, Japan and other major creditors to overcome glaring cash shortage to keep the government operating and repay interest and principle on the debt.

Related: Deficit Hawks Take Trump on an Ominous Tour of the Fiscal Cliff

Unless the Trump administration and Congress can agree by this fall to raise the debt ceiling and increase the Treasury’s borrowing authority, the government could be facing its first default in history and a partial government shutdown.

 “The higher the government’s interest costs, the more difficult it would be to achieve any particular target for lower budget deficits: Tax increases, spending reductions, or both would have to be greater,” according to the CBO. “Such policy changes could affect the economy and people’s well-being.”

If, for example, policy changes lead to an increase in marginal tax rates, the larger the increase the more people’s incentives to work would diminish, the report said. “Alternatively, if policy changes included a reduction in federal spending for investment, the greater that reduction, the more both output and income would be reduced,” the agency argued.

CBO warns that mounting debt levels could have the effect of shrinking the economy by three percentage points between now and 2047. That would have the effect of stunting average income growth by as much as $4,000 a year – from a projected $90,000 a year to only $86,000 while discouraging government and private investment.

Related: Budget Watchdog to Trump: Government Spending Is on an Unsustainable Path

The Committee for a Responsible Federal Budget, in commenting on the CBO report, wrote that “If policymakers add to the debt, income growth will slow further.” For example, if Congress and the Trump administration were to enact $2 trillion of tax cuts and spending increases over the next decade, “average income will fall by an additional $2,000 per person by 2047,” according to CRFB.

Besides cooling off the economy, CBO said, the mounting national debt may squeeze out other important priorities. That will make it more difficult for the government to respond to emergencies, such as natural disasters and wars, and it could ultimately increase the risk of another fiscal crisis or government shutdown.

The biggest drivers of government spending – Social Security, Medicare and Medicaid, and interest payments on the debt – taken together will nearly double in cost from 11.8 percent of the overall economy in 2017 to 21.8 percent by 2047.

CBO also predicts that rising debt will have the perverse effect of further pushing up interest rates and adding to the government’s overall costs.

Under that scenario, the government would end up paying interest rates 0.5 points or 13 percent higher than they otherwise would be by 2047 if the government had done a better job of controlling the debt. At the same time, 10-year Treasury notes would be 0.9 points or 23 percent higher than they otherwise would be.

Those rising interest rates would not only further boost interest costs for the federal government, but would “likely flow through to higher interest rates on mortgages, credit cards, car loans, and business loans,” the CRFB says.