Uncle Sam’s Interest Payment Time Bomb

When measuring the size of federal spending, it is standard practice to measure spending as a percent of Gross Domestic Product (GDP). However, there are times when measuring the nominal dollar amount of federal spending is the more relevant measure–as I did in my recent post “Fiscal Cliff Solved? Not Without Spending Cuts.”

It is that surge in spending that has resulted in the trillion dollar deficits in recent years. According to the most recent data from the Congressional Budget Office (CBO), gross federal debt in 2012  stood at $16.048 trillion. The debt is projected to grow by 63 percent to $26.079 trillion in 2023.

When it comes to debt, it is the amount that matters the most.  Why? Because Uncle Sam pays interest on the nominal value of debt.  In 2012, Uncle Sam paid $223 billion in interest and is projected to grow nearly 3-fold by 2023 to $857 billion (which will be more than the $731 billion Uncle Sam will spend for defense).

Of course, Uncle Sam’s interest bill is dependent on the interest rate–higher interest rates also mean higher interest payments.  CBO’s forecast only assumes that interest rates return to their historical average of approximately 5.2 percent. However, what happens if interest rates go higher than that? A scenario that is very likely given the large amounts of newly printed dollars.

The chart below shows the results of a CBO interest rate analysis, updated by the Mercatus Center, that finds interest payments would climb over $2 trillion, per year by 2021 and beyond if interest rates were to climb to the average seen in the 1980s (over 10 percent). This would be higher than Uncle Sam’s spending on all entitlements (Social Security, Medicaid, Medicare, etc.) of $1.845 trillion in 2023.

Chart Showing Uncle Sam's Interest Rate Risk

This ticking interest payment time bomb is why it is not enough to simply let the deficit fall as a percent of GDP. The deficit needs to fall to zero dollars ASAP. As I will explore in future posts, doing so will mean tackling entitlements. Unfortunately, President Obama has all but taken entitlement reform off the table which only serves to keep the time bomb ticking . . . tick tock, tick tock.