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In 2022, the federal government spent $476 billion on net interest costs on the national debt. That total, which grew by 35 percent from $352 billion in 2021, was the largest amount ever spent on interest in the budget, and equaled nearly 2 percent of gross domestic product (GDP). Interest costs are on track to become the largest category of spending in the federal budget — but what comprises the government’s net outlays on interest, and what affects the size of such costs?
In the late 1970s, the increasing national debt and higher interest rates led to a boost in interest costs, which reached a historic high of 3.2 percent of GDP in 1991 (looking at interest costs as a percentage of the economy allows for a standardized comparison over time). But smaller budget deficits and lower interest rates decreased that ratio over the following decade. Between 2007 and 2020, outlays for interest remained steady at around 1.5 percent of GDP (even though borrowing related to the financial crisis and pandemic was quite high), mostly because of low interest rates. But due to the recent rise in inflation and interest rates, as well as the mounting public debt, interest payments have grown rapidly over the past two years, and they are projected to continue growing. The Congressional Budget Office (CBO) projects that interest costs will exceed their previous high relative to the size of the economy, reaching 3.2 percent of GDP ($1.1 trillion) in 2029.
Net interest costs include the interest paid by the government minus the interest and investment income it receives. For the most part, the interest category corresponds to interest paid on debt held by the public; while the government also issues debt to trust funds and other government accounts, interest payments to those entities are intragovernmental transactions and so have no net effect on the overall budget. The government also pays and receives interest through a number of other federal programs, but such sums are relatively small.
Gross interest outlays mostly reflect payments on debt held by the public as well as intragovernmental payments on debt held by government accounts, primarily the trust funds for Social Security and pensions for retired military and civilian federal workers. Altogether, gross interest totaled $718 billion in 2022. Other examples of programs to which the government pays interest include:
Finally, investment earnings and losses from the National Railroad Retirement Investment Trust (NRRIT), an independent entity that manages and invests the assets of the Railroad Retirement program, is recorded in the federal budget in the category of net interest. While the trust’s earnings averaged $2 billion in the past decade, the trust suffered a loss of over $3 billion in 2022 — thereby adding to net interest costs.
Interest receipts come primarily from Treasury securities held by federal trust funds (the interest payments are also recorded in the budget). In 2022, trust funds such as those for Social Security and for pensions of retired federal workers were credited with $184 billion in intragovernmental interest. Similarly, a number of other government accounts, such as the Department of Defense Medicare-Eligible Retiree Health Care Fund, received $31 billion in interest. The federal government also receives interest from other sources:
The government’s interest costs are mainly determined by the interest rates on U.S. Treasury securities and the amount of debt held by the public.
Before the past year or so, short-term interest rates in recent decades were declining or near zero; such rates are generally controlled by the Federal Reserve through the federal funds rate. During the COVID-19 pandemic, the Fed kept the federal funds rate near zero to support economic recovery. However, in response to the significant rise in inflation in 2022, the Fed raised the target range for the federal funds rate (which the Fed uses to moderate interest rates) to between 5.0 and 5.25 percent — a 16-year high. Expectations about short-term interest rates and concerns about inflation have also boosted longer-term rates. According to CBO, short-term interest rates are estimated fall to 2.5 percent by 2025 and average around 2.3 percent between 2025 and 2033, but long-term rates will remain around the current level over the next decade.
The size of the public debt also influences the government’s net interest costs. The total public debt represents an accumulation of past federal deficits. In all but four years since 1970, the government ran deficits, which caused the national debt to grow at a rapid pace. At the end of fiscal year 2022, debt held by the public totaled $24.3 trillion, or 97 percent of GDP. Under current laws, debt held by the public is expected to reach an all-time high of 106 percent of GDP in just five years and grow to become almost twice that size by 2053.
In the past, increases in deficits and the debt were associated with temporary or one-time episodes, such as war or economic downturns. Now, however, deficits have become the norm due to the structural mismatch between federal spending and revenues. CBO estimates that the gap will continue to grow; federal spending is projected to grow from 24.2 percent of GDP in 2023 to 30.2 percent by 2053, while revenues would only climb from 18.4 percent of GDP in 2023 to 19.1 percent in 2053.
Rising interest rates and growing national debt cause federal interest costs to rise. And interest costs, in turn, contribute to the growth of federal spending — continuing a vicious cycle of borrowing, interest, and higher debt. Interest costs also crowd out opportunities for investment in other important priorities. In fact, the government is already on a path to spending more on interest costs than its spending on education, research and development, and infrastructure combined. If unaddressed, the growing borrowing costs will pose significant challenges for our nation’s fiscal future.