Deck the Halls with Fiscal Folly

S ince Congress passed a continuing resolution to fund the government until February, discussion about reining in deficit spending has largely gone quiet. When policy-makers return from their holiday break, one important factor they should consider is the spike in interest payments adding to the growing public-debt burden — it’s going to get worse than most realize.

Rapidly rising interest payments on public debt are a stark warning of a looming financial storm, which threatens to unleash years of high debt-servicing costs, crippling the government’s ability to fund essentials and jeopardizing programs relied upon by millions of Americans. To ignore what may be coming is not a realistic option.

The link between interest rates and debt-servicing costs is crucial to understanding the nature of this challenge. Just as a ship can’t respond instantaneously to a change in direction, interest payments lag behind shifts in interest rates, roughly mirroring the average maturity term of outstanding public debt. The rise in interest rates over the past two years, therefore, has set the stage for a future surge in debt-servicing costs, significantly affecting the federal budget. Interest payments on the debt have already increased from $352 billion in fiscal year 2021 to $659 billion in fiscal year 2023, and they are likely to be around $900 billion this year.

In the early 1980s, when interest rates reached double-digit percentages, exceeding 14 percent, and then took some time to subside, the nation witnessed a dramatic rise in interest payments, peaking in the early 1990s at 3.16 percent of GDP. The lag between the interest-rate spike and the interest-payment surge roughly reflected the average maturity of outstanding debt at the time — about five years in 1985.

While the average duration of debt maturity today is slightly longer than it was then, our current debt, which is far larger, remains relatively short-term — with an average maturity of six years. Our failure to significantly extend the maturity of federal debt during the years of ultralow interest rates was a hugely expensive, wasted opportunity.

Those who underplay the seriousness of our fiscal situation might argue that interest rates of 12 percent in the early 1980s were nothing like the 4–5 percent rates we see today. This approach ignores the simple fact that today, the debt-to-GDP ratio stands at 100 percent, four times larger than it was in 1981. This means that even with lower interest rates than we saw in the early 1980s, servicing the debt translates to a significantly larger financial burden than it did then.

In fiscal years 2022 and 2023, the Treasury rolled over $13 trillion of debt. During this two-year period, the average interest rate on debt held by the public roughly doubled. The Treasury is set to roll over another $8.5 trillion in fiscal year 2024, and the average interest rate on treasuries is now 3.1 percent compared with 1.6 percent just two years ago.

In the coming years, we are likely to see debt-servicing costs that consistently exceed 3 percent of GDP. For comparison, the federal government spent 3 percent of GDP on the entire defense budget in fiscal year 2022. This would severely cripple the government’s ability to address other critical spending priorities and would put large federal programs at risk. From education and infrastructure to health care and defense, few, if any, sectors will be spared from the tightening grip of rising debt.

But the fiscal storm doesn’t end there. Without substantial reforms — spending cuts or new revenue sources — the Social Security and Medicare systems will be unable to meet their full obligations by 2033 and 2031 respectively.

Meanwhile, we’re expected to run a $20 trillion cumulative deficit between 2024 and 2033. Then there are the expiring provision of the Tax Cuts and Jobs Act (TCJA) of 2017, which are scheduled to sunset in 2025. As economist Doug Holtz-Eakin points out, “making all the provisions permanent is estimated to increase deficits by a bit over $3 trillion over 10 years.”

Despite the severity of these challenges, many economists and policy-makers remain complacent. This inaction is not only irresponsible but also dangerous. It is time for those on both sides of the political aisle to face reality and work together to address this crisis.

The recent creation of a fiscal commission may appear to be a step in the right direction, but if it follows the pattern of previous commissions, characterized more by rhetoric than results, it may well prove woefully inadequate to address our perilous fiscal trajectory.

A more promising approach would be to implement legally binding fiscal rules — similar to the Swiss or German “debt brake” laws or the Danish spending-ceiling rules — that apply broadly across the federal budget, accompanied by an independent oversight council empowered to enforce fiscal discipline. This combination would create a fire wall against political meddling and inaction, ensuring that we adhere to a sustainable fiscal path.

We cannot afford to delay action any longer.