Rising debt causes rising interest costs that consume federal revenues and undermine federal spending
Boccia and Lett, 23 (2/1/2023; Romina Boccia is director of budget and entitlement policy at the Cato Institute, where she specializes in federal spending, budget process, economic implications of rising debt, and Social Security and Medicare reform, MA in Economics from George Mason University, Dominik Lett is a Research Associate at the Cato Institute, BA in Political Science from Wichita State University; “The Debt Limit and the High Costs of Debt”; Cato Institute; https://www.cato.org/blog/debt-limit-high-costs-debt) //LVL
On January 19, U.S. borrowing exceeded $31.4 trillion, the statutory debt limit. To continue borrowing, Treasury Secretary Janet Yellen began using so‐called extraordinary measures (debt limit loopholes), buying the administration and Congress time to negotiate. Both parties are now amid a political showdown that may determine the future of U.S. fiscal policy.
Beyond click‐bait headlines about a debt default, lawmakers and the public should know that if the debt continues to grow rapidly, it will bode ill for the U.S. economy, business investment, and government policy. High and rising debt slows growth, crowds out private investment, limits the government’s ability to respond to unforeseen emergencies, and elevates the risk of a sudden fiscal crisis where investors would lose confidence in U.S. Treasury bonds and the U.S. dollar.
$31 trillion in gross federal debt is unprecedented in U.S. history. This level of debt is greater than the annual economic output of the entire country, as measured by gross domestic product (GDP). Divided among the U.S. population, the total federal debt is at $94,000 per person or $240,000 per U.S. household. Such high debt is a big burden with far‐reaching consequences, including:
Higher interest costs. Rising debt, without a reduction in interest rates, means higher interest payments. As the government borrows more, interest costs rise. Under baseline projections by the Congressional Budget Office (CBO), net interest costs will rise to 7.2 percent of GDP by 2052. That means that interest costs alone will consume 40 percent of federal revenues by 2052. As interest costs make up a larger share of the federal budget, policymakers will be forced to choose between paying interest on the debt and providing funding for other critical spending priorities, such as national defense and public health.
Rising debt further increases interest costs. The American Enterprise Institute’s (AEI) John Mantus and Mark Warshawsky found that a “1 percentage point increase in the federal debt‐to‐gross‐domestic‐product ratio is associated with an increase of nearly five basis points in the long‐term interest rate…double what the Congressional Budget Office uses in its budget projections.” Interest rates that exceed CBO projections by just one percentage point could add another $30 trillion in interest costs over 30 years.
As the debt burden and interest costs rise, investors are likely to become increasingly concerned about the government’s ability to service debt. If investors demand even higher Treasury yields to continue lending after perceiving elevated risk, this means yet higher interest rates. Under the AEI model, higher‐than‐expected interest rates cause the debt‐to‐GDP ratio to rise to 235 percent by 2052 compared to the 185 percent forecasted in the CBO extended baseline.
Foreign investors, who hold approximately one‐third of publicly held federal debt, will receive increased interest payments as interest rates rise. These elevated interest payments to foreign holders of U.S. debt would reduce America’s net international income (the difference between a nation’s income and its total production). Higher interest costs reduce America’s relative international economic standing while making the United States government increasingly dependent on foreign and domestic creditors.