Interest on the National Debt and How It Affects You
The interest on the national debt is how much the federal government must pay on outstanding public debt each year. The national debt includes debt owed to individuals, to businesses, and to foreign central banks, as well as intragovernmental holdings.
Intergovernmental vs. Public Debt
The intragovernmental debt is what the government owes the Social Security Trust Fund and other federal agencies. It’s not part of the public debt and it doesn’t impact the interest on that debt. It’s money the government owes itself.
The debt held by the public—$22.3 trillion as of January 2022—is held in the form of Treasury bills, notes, and bonds, as well as Treasury Inflation-Protected Securities (TIPS), savings bonds, and other securities. The majority of the public debt is owned by the American people, either through individual investors, the Federal Reserve, or state and local governments.1
The total national debt was over $28 trillion for most of 2021. Congress raised the debt limit to $28.4 trillion on Aug. 1, 2021 to accommodate this, then it raised it again by another $2.5 trillion on Dec. 16, 2021.23 The interest on the public debt for fiscal year 2021 is estimated to be $413 billion, according to the Congressional Budget Office (CBO).4
How Is Interest Calculated on the Public Debt?
The interest on the national debt is calculated by multiplying the face value of outstanding Treasurys by their interest rates. Treasury bills have short durations, ranging from a few days to 52 weeks. Notes are sold in two-, three-, five-, seven-, and 10-year durations, while bonds are for 15 and 30 years.
Short-term debt tends to have a lower interest rate than long-term debt. Investors don’t demand as much of a return when lending their money for a shorter period.
The interest rate on each bill, note, or bond depends on when it was issued. Interest rates change over time, depending on the demand for U.S. Treasuries. You can expect the interest rates will be low when demand is high. The government has to pay a higher interest rate to sell all its bonds when demand falls. This causes the Treasury yield curve to change over time.
The interest on the U.S. national debt isn’t easy to calculate. You can’t simply multiply the total outstanding debt number by the interest rate to get the correct figure. But a large debt issued during a high-interest rate environment will often create a large interest payment.
Interest on the Debt by Year
The interest on the debt was $253 billion in 2008. It consumed 8.5% of the fiscal year (FY) 2008 federal budget. It declined to $197 billion in 2010 because interest rates fell.5 Its interest payments as a percentage of GDP increased by less than 0.01% as a result, even though public debt increased.6
It remained below $250 billion from 2009 to 2015, even though the national debt almost doubled as public spending skyrocketed and revenue plummeted.7 The costs of the debt didn’t increase as substantially as the debt levels themselves, even though President Barack Obama created significant debt during his time in office.
The yield on the 10-year Treasury note was below 2% for all of 2021.8 The CBP estimated that the interest on the public debt was $413 billion for fiscal year 2021.4 The CBO does project that the Treasury Yield will rise to 3.5% by 2030.9
President Joe Biden and the government released the fiscal year budget for 2022 in the first half of 2021. The table below includes figures from that budget. The interest on the debt (net interest) information and total outlays can be found in Table S-4. Dividing the interest into the total outlays gives us the percentage of the budget for the fourth column. The 10-year interest rate figures used in these calculations can be found in Table S-9. Public debt is found in Table S-1.10
|Fiscal Year||Interest on the Debt (in billions)||Interest Rate on 10-Year Treasury||Public Debt (in billions)||Percent of Budget|
Why Does Interest Rise?
Higher interest rates and growing debt are two of the main causes of the interest on the debt. But what causes them to rise?
Interest rates increase when the economy is doing well. Investors have the confidence to buy riskier assets, such as stocks. There’s less demand for bonds, so the interest rates must rise to attract buyers.
The debt is the accumulation of each year’s budget deficit. This happens each year when spending is greater than revenue. A larger debt also affects the deficit, thanks to the higher interest payment.
Each president and Congress since President Bill Clinton’s administration has planned to overspend.11
First, deficit spending stimulates the economy by putting money into the pockets of businesses and families. They purchase goods and hire workers, creating a robust economy. Government spending is a component of GDP for this reason.
Second, the U.S. can rely on countries such as China and Japan to lend it the money to buy their products. The U.S. owes China and Japan more than any other country as a result.12
Finally, politicians get elected to create jobs and grow the economy. They tend to lose elections when unemployment and taxes increase. Congress has little incentive to reduce the deficit as a result.
How the Interest on the Debt Affects You
The interest on the national debt immediately reduces the money available for other spending programs. Advocates of certain benefits will call for a reduction in spending in other areas as it increases.
A growing debt burden becomes a big problem for everyone in the long term. The World Bank says a country reaches a tipping point when the debt-to-GDP ratio approaches or exceeds 77%.13 The U.S. debt-to-GDP ratio was around 125% through most of 2021.
Gross domestic product measures a country’s entire economic output. Lenders worry whether the country will repay them when a country’s debt is close to or greater than the entire country’s production.
Lenders became concerned in 2011 and 2013 when tea party Republicans in Congress threatened to default on the U.S. debt.
Lenders demand higher interest rates when lenders become concerned. Buyers of U.S. Treasuries appreciate the security of knowing that they’ll be repaid. They’ll want compensation for the increased risk. Diminished demand for U.S. Treasuries would further increase interest rates, which slows economic growth.
Lesser demand for Treasuries also puts downward pressure on the dollar because the dollar’s value is tied to that of Treasury securities. As the dollar declines, foreign holders are paid back in a currency that is worth less than what they anticipated when they originally lent the money. This further decreases demand and creates a vicious cycle.
Ways to Reduce Interest on the Debt
Rising interest on the debt worsens the U.S. debt crisis. Congress has a few options when it comes to reducing the interest owed on the national debt.
Lower Interest Rates
This is the most painless way to lower interest paid, but it’s heavily dependent on other economic factors. The Fed dropped interest rates as low as possible when the COVID-19 pandemic hit the U.S. in 2020.14
Increase Tax Revenues
Increasing tax revenues will lower the deficit and add less to the debt. Tax increases are an immediate solution, but they also slow economic growth. Voters often reject politicians who raise taxes. A fast-growing economy will also boost tax revenues.
This strategy will anger whoever is seeing their benefits reduced. Politicians often talk about cutting spending, but they usually want to cut someone else’s spending. They could face a political cost if they cut their own spending or spending that impacts constituents.
Shift Federal Spending
Congress can shift spending to activities that create the most jobs and maximize economic growth, rather than cutting. A University of Massachusetts Amherst study found that tax cuts create 15,100 jobs for every $1 billion put back into the economy.
That’s better than defense spending, which creates just 11,200 jobs for every billion spent. But neither is as cost-effective as education spending, which creates 26,700 jobs for each billion spent.15 Spending on education appears to be one of the best unemployment solutions available.