(Bloomberg) — The US debt interest-cost burden climbed to the highest since the 1990s in the financial year that’s just ended, escalating the risk that fiscal worries limit the policy options for the next administration in Washington.
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The Treasury spent $882 billion on net interest payments in the fiscal year through September — an average of roughly $2.4 billion a day, according to data the department released Friday. The cost was the equivalent of 3.06% as a share of gross domestic product, the highest ratio since 1996.
Historically high budget deficits, which caused total debt outstanding to soar in recent years, are a key reason for the increase. Those deficits reflect a steady rise in spending on Social Security and Medicare, as well as the extraordinary spending the US unleashed to battle Covid and constraints on revenue from sweeping 2017 tax cuts. Another big driver: the inflation-driven surge in interest rates.
“The higher interest costs are, the more politically salient these issues are,” said Wendy Edelberg, director of the Brookings Institution’s Hamilton Project. It raises the chance of politicians recognizing that “funding our spending priorities through borrowing is not costless,” she said.
While neither former President Donald Trump nor Vice President Kamala Harris has made deficit reduction a central element of their campaign, the debt issue looms over the next administration nonetheless. With Congress heading for a narrow partisan split, it could only take a handful, or potentially lone, deficit-wary legislator to stymie tax and spending plans.
That scenario was already seen in the outgoing Biden administration, when then-Democrat Joe Manchin forced a scaling back of spending items the White House favored as the price for passing signature legislative packages in 2021 and 2022.
Even if Republicans take control of both chambers, and Trump takes the White House, the likely narrowness of the majority could leave GOP fiscal hawks with the power to demand changes to sweeping tax cuts.
“It would just be remarkable if what came out of the tax debate next year was a whole group of policymakers looking at our debt trajectory and deciding just to make it worse,” said Edelberg, a former chief economist at the Congressional Budget Office.
The net interest bill exceeded the Defense Department’s spending on military programs for the first time, according to data from the Treasury Department and the Office of Management and Budget. It also amounted to about 18% of federal revenues — almost double the ratio from two years ago.
The Federal Reserve’s shift to lowering rates is offering some relief to the Treasury. The weighted average interest on outstanding US debt was 3.32% at the end of September, marking the first monthly decline in nearly three years.
Even so, the scale of the interest costs is now so large that they are by themselves adding to the overall debt load held by the public, which stands at $27.7 trillion — approaching 100% of GDP. Debt servicing was among the fastest growing parts of the budget last year. Spending on interest also risks weighing on economic growth by crowding out private investment.
The nonpartisan CBO estimates that every additional dollar of deficit-financed spending reduces private investment by 33 cents.
“From a variety of standpoints, the fact that the interest costs are growing the debt and causing other economic ramifications is a problem for our economy,” said Shai Akabas, executive director of the Bipartisan Policy Center’s Economic Policy Program.
Treasury Secretary Janet Yellen has played down concerns, saying that the key metric to track in assessing US fiscal sustainability is inflation-adjusted interest payments compared with GDP. That ratio has jumped the past year, but the White House sees it stabilizing at about 1.3% over the coming decade. Yellen has said it’s important to stay below 2%, a level seen by some as a key threshold for sustainability.
The White House projections, however, assume passage of revenue-raising measures that the outgoing Biden administration proposed. Harris, too, has called for raising taxes on the wealthiest Americans and on corporations.
Trump says the key to addressing the fiscal outlook is yet more tax cuts, which he argues will boost economic growth, offsetting the hit to the government’s bottom line.
Most economists see debt continuing to climb under either candidate. The Committee for a Responsible Federal Budget estimates the Harris economic plan would increase the debt by $3.5 trillion over a decade, while Trump’s would sending it soaring by $7.5 trillion.
Besides the election outcome, the magnitude of Fed rate cuts will affect the fiscal outlook. While rate hikes were quickly reflected in the Treasury’s interest bill after policymakers kicked them off in March 2022, rate cuts may take more time to bring down the government’s borrowing costs.
That’s in part because a swath of the US debt maturing in coming years carries particularly low rates, which preceded the Fed’s tightening cycle. Many securities will be replaced by Treasuries that will be costlier to service. And that may prove to be the case for years to come — especially if the Fed halts rate cuts at a higher level than pre-Covid. The Fed’s short-term benchmark rate averaged less than 0.75% over the decade through 2019; policymakers in September projected the rate would settle around 2.9% in time.
In the meantime, costs tied to Social Security and Medicare will keep rising as the US population ages, contributing to outsize budget deficits for decades ahead unless reforms are made. That pressure, and an aversion of politicians to take on changing the popular programs, has put pressure on the remaining areas of federal spending, known as discretionary.
Back in the 1960s, discretionary spending made up about 70% of the federal total, but now the ratio is just 30%, according to analysis by Torsten Slok, chief economist at Apollo Global Management.
For now, investors are showing little sign of concern about US fiscal challenges, with the Fed’s easing cycle and concerns about a weakening job market continuing to support demand for Treasuries. But if and when they do, that could prove decisive for Washington, said Gary Schlossberg, global strategist at Wells Fargo Investment Institute.
“The landscape has changed,” Schlossberg said. “Before, we had more of a free ride — with rates low. You could run up the debt and it didn’t really show up much in interest expenses. That’s obviously not there now.”
–With assistance from Ben Holland and Liz Capo McCormick.
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