As America prepares for another $1.9 trillion in federal coronavirus relief, the day approaches when policymakers and taxpayers will have to sit down at the proverbial kitchen table and look at the books. Yes, the coronavirus is very much still here; there are lots of people suffering, and Americans’ wants are many.
Even so, Americans have no choice but to come to grips with federal spending and growing debt. And the United States has time to do it. Otherwise, an ugly federal spending collision lies in the offing.
Consider that the federal budget contains three broad categories: discretionary, nondiscretionary, and net interest payments. In the first category in 2020, there was $713 billion for defense and $724 billion for nondefense, or all the rest of government. Under nondiscretionary, there was $2.97 trillion for Social Security, Medicare and Medicaid.
Finally, there was $376 billion provided for net interest payments. It’s a net figure because the federal government both earns and pays interest. The 2020 interest cost of the debt came in at $522.7 billion.
Of course, the interest cost of the debt is determined by the total amount of outstanding national debt and the average interest rate paid on that balance. The current low-interest rate environment makes a huge difference. On January 31, the total debt outstanding stood roughly at $27.7 trillion. On the same date in 2020, it was $23.3 trillion, and reaching back to 2015 was $18 trillion. Federal debt has increased by almost $10 trillion, or 56 percent, in six years.
The average interest rate paid on the federal debt on January 31 was 1.687 percent. A year earlier, it was 2.418 percent. On January 31, 2015, the average was 2.384 percent. So, while debt outstanding has skyrocketed, the average interest rate has fallen by 29 percent. That leaves the obvious question: Will the low rates continue?
The cost of the debt in 2015—when the amount owed was far smaller but the average interest rate higher—was $402.4 billion, or about $120 billion less than in 2020. But what if interest rates rise across the next couple of years and debt outstanding stays at the current $27.7 trillion? Suppose rates rise by 40 basis points, which is the level predicted by the Congressional Budget Office (CBO), or by 80 basis points, the amount predicted by Wells Fargo?
If the more pleasant CBO outcome prevails, the interest cost of the debt would rise 24 percent to $647 billion. If the Wells Fargo forecast holds, it would rise 48 percent to $772 billion. In just two years, the annual bill rises by as much as $125 to $250 billion. If the higher number prevails, interest on the debt would begin to approximate the size of the defense budget. (We should recognize there are interest earnings that would accrue to the federal government also, which would lessen the blow only somewhat.)
So far, these concerns have been dealing with numbers, budgets, debt, and interest rates. But here is the real issue that lies behind the numbers: What do people wish to have happen with their tax payments? Would they rather Americans’ taxes pay interest or go to provide improved infrastructure? Or what about a more solvent Environmental Protection Agency or support more Pell grants for students? What is the opportunity cost associated with the interest cost of the debt?
When higher interest costs arrive—and that day will surely come—politicians will have to put the squeeze on defense and the rest of government. Social Security, Medicare and Medicaid will likely be untouchable for as long as it can be delayed. All these things together make finding $125 billion or $250 billion like trying to get blood out of a turnip.
For example, EPA’s 2021 budget was $6.6 billion. The Department of Transportation’s budget stood at $89 billion. The Department of Education budgeted $22.5 billion for Pell Grants. Taking the three together—all of it—would just yield $118 billion. And no one wants to cut these programs.
So how do Americans and policymakers prepare for a “rainy day” that is more like a torrential downpour? Does the United States wait for the collision or find a better path to travel? Prudence and common sense warn Washington to cut back on deficit spending, pay down debt, and at least control Americans’ appetite for federal assistance.
Higher interest rates will arrive one of these days; America should prepare for that now.
Bruce Yandle is a distinguished adjunct fellow with the Mercatus Center at George Mason University, dean emeritus of the Clemson College of Business and Behavioral Sciences, and a former executive director with the Federal Trade Commission.