(Bloomberg) — U.S. debt interest costs rose to the highest level since the 1990s in the just-ended fiscal year, raising the risk that fiscal concerns will limit the next administration’s policy options in Washington.
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The Treasury Department spent $882 billion on net interest payments in the fiscal year that ended in September, an average of about $2.4 billion a day, according to data released by the department on Friday. This cost was equivalent to 3.06% of gross domestic product, the highest percentage since 1996.
Historically high fiscal deficits have been the main reason for the rapid increase in debt outstanding in recent years. These deficits reflect steady increases in spending on Social Security and Medicare, as well as the extraordinary spending the United States has undertaken to fight the coronavirus and revenue constraints from deep tax cuts in 2017. . Another major factor is the rise in interest rates due to inflation.
“The higher the interest costs, the more politically salient these issues become,” said Wendy Edelberg, director of the Hamilton Project at the Brookings Institution. This makes it more likely that politicians will realize that “it’s less costly to finance spending priorities through borrowing,” he said.
Although neither former President Donald Trump nor Vice President Kamala Harris have made deficit reduction a centerpiece of their campaigns, the debt issue still looms over the incoming administration. With Congress heading toward a narrow partisan divide, the possibility of just a handful, or even one, of deficit-cautious lawmakers could derail tax and spending plans.
This scenario has already been seen in the outgoing Biden administration, where then-Democrat Joe Manchin forced cuts to spending items favored by the White House in exchange for passing signature legislation in 2021 and 2022.
Even if Republicans control both houses of Congress and Mr. Trump wins the White House, the slim majority would likely leave Republican fiscal hawks with the power to push for significant changes to tax cuts. be.
“It would be surprising if in next year’s tax debate a whole group of policymakers looked at the trajectory of the debt and decided to make it even worse,” said Edelberg, a former chief economist at the Congressional Budget Office. said.
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For the first time, the net interest bill exceeded Pentagon military program spending, according to data from the Treasury Department and the Office of Management and Budget. This represents about 18% of federal revenue, almost double the rate from two years ago.
The Fed’s shift to lower interest rates is providing some relief to the Treasury. As of the end of September, the weighted average interest rate on U.S. Treasuries outstanding was 3.32%, the first monthly decline in about three years.
Still, the scale of interest costs is currently enormous, with total national debt on its own reaching $27.7 trillion, approaching 100% of GDP. Debt servicing was one of the fastest growing parts of last year’s budget. Spending on interest risks crowding out private investment and squeezing economic growth.
The nonpartisan CBO estimates that for every dollar of deficit spending, private investment decreases by 33 cents.
“From a variety of perspectives, the fact that interest costs are increasing debt and causing other economic impacts is a huge problem for our economy,” said Shai Akabas, executive director of the Bipartisan Policy Center’s Economic Policy Program. It’s a problem.”
Treasury Secretary Janet Yellen downplayed the concerns, saying the key metric to track when assessing the U.S.’s fiscal sustainability is inflation-adjusted interest payments relative to GDP. The rate has skyrocketed over the past year, but the White House expects it to remain stable at about 1.3% over the next 10 years. Yellen said it’s important to keep it below 2%, a level considered by some to be an important criterion for sustainability.
However, the White House’s projections assume the passage of revenue increases proposed by the outgoing Biden administration. Harris also advocates raising taxes on America’s wealthiest citizens and corporations.
President Trump has said the key to addressing the fiscal outlook is further tax cuts, arguing that tax cuts will boost economic growth and offset the hit to government revenues.
Most economists believe debt will continue to rise under either candidate. The Committee for a Responsible Federal Budget estimates that Harris’ economic plan would increase the debt by $3.5 trillion over 10 years, while President Trump’s economic plan would increase the debt by $7.5 trillion.
In addition to the election results, the size of the Fed’s rate cuts will also affect the fiscal outlook. After policymakers began raising interest rates in March 2022, the rate hikes were reflected in the Treasury’s interest bill immediately, but rate cuts could take longer to lower the government’s borrowing costs. .
Part of the reason is that some U.S. Treasuries maturing in the next few years have particularly low interest rates ahead of the Fed’s tightening cycle. Many securities will be replaced by government bonds, which have higher servicing costs. And that could continue for years, especially if the Fed stops cutting rates at higher levels than before the coronavirus. The Fed’s short-term benchmark interest rate averaged less than 0.75% over the 10 years ending in 2019. Policymakers predicted in September that interest rates would eventually settle around 2.9%.
Meanwhile, costs associated with Social Security and Medicare will continue to rise as the U.S. population ages, leading to large budget deficits for decades to come unless reform is implemented. That pressure, and politicians’ reluctance to make changes to popular programs, is putting pressure on the remaining areas of federal spending, known as discretionary.
In the 1960s, discretionary spending accounted for about 70% of the total federal government, but today it only accounts for 30%, according to an analysis by Torsten Slok, chief economist at Apollo Global Management. There is.
So far, investors have shown little sign of concern about U.S. fiscal problems, with concerns about the Fed’s easing cycle and a weakening job market continuing to support demand for Treasuries. But if that happens, it could be decisive for the U.S. government, said Gary Schlossberg, global strategist at Wells Fargo Investment Institute.
“Things have changed,” Schlossberg said. “It used to be cheaper and you could get more free rides. You could end up going into debt, but it doesn’t really reflect much in interest. That obviously doesn’t exist now.”
–With assistance from Ben Holland and Liz Capo McCormick.
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