Tuesday, January 4, 2011

An Interesting Look at the Interest on the U.S. Debt







Updated to July 18th, 2011

I apologize in advance for the second depressing posting in a row but I thought I'd get this posted now since the subject is linked to my last article.

In looking through this document from the Congressional Budget Office last week, I found this particularly frightening line:

"Interest payments, which absorb federal resources that could otherwise be used to pay for government services, currently amount to more than 1 percent of GDP; under this scenario, they would rise to 4 percent of GDP (or one-sixth of federal revenues) by 2035."

Needless to say, it caught my eye.  I thought that it was well worth looking into a bit deeper.

The document in question is a report entitled "The Long-Term Budget Outlook" dated June 2010 and revised August 2010.  It is a cornucopia of interesting very long term fiscal projections by the Congressional Budget Office.

The scenario of which the CBO speaks is one that they term the "extended-baseline scenario".  In this scenario, long-term tax increases would take place in lockstep with economic growth, the tax cuts of 2001 and 2003 would expire and overall total government revenue would rise to 23 percent of GDP by 2035 (and increase thereafter), a much higher rate than the norm seen in recent decades.  On the spending side, government spending on everything other than mandatory health care programs, Social Security and interest on the federal debt would decline to the lowest percentage of GDP since before World War II.  Yup, that's going to happen.  This would mean cuts in just about all domestic programs including national defence.  To summarize, in this out-of-this-world scenario, the CBO hopes that the increase in revenue and decrease in most domestic program spending will offset MOST of the rise in spending on health care and Social Security necessitated by the baby boomers moving into their senior (and more expensive) years. 

If this "Alice In Wonderland" scenario takes place, than and only then will federal debt held by the public grow from 62 percent of GDP this year to 80 percent of GDP by 2035.  Then, and only then, will interest payments only rise to 4 percent of GDP as noted above.

Three letters: OMG.  Basically the CBO, in its wildest dream state, can only fudge the revenue and expenditure numbers enough to keep our interest payments down to one-sixth of federal revenues by 2035

Just in case you thought that the extended-baseline scenario wasn't the stuff made of nightmares, here's the CBO's other scenario.  This scenario has the rather innocuous-sounding moniker "alternative fiscal scenario".  It doesn't sound that bad, does it?  Certainly, it couldn't be any worse than having a root canal, could it? Under the alternative fiscal scenario, the CBO assumes that Medicare payment rates for physicians would gradually increase (they won't under current legislation) and that several policies enacted recently that would restrain growth in health care expenditures will not continue after 2020.  Once again, as seen in the extended-baseline scenario, spending on other activities other than mandatory health care programs, Social Security and interest on the federal debt would fall below the average level of the past 40 years relative to GDP but not as low as under the extended-baseline scenario.  The CBO also assumed that most of the provisions of the 2001 and 2003 tax cuts would be extended, among other things, which would keep tax revenues near their historical average of 19 percent of GDP.  Should the CBO's worst-case (and probably most likely) scenario unfold, interest payments would rise to 9 percent of GDP or roughly one-third of revenues by 2035 and much more in later years because of ballooning debt.  While not used in the CBO scenarios, they state that as the debt rose, upward pressure on interest rates would be exerted making interest outlays even larger.

Let's take a graphical look at the two budget scenarios noting that the top chart is the best case scenario and the second chart is the one that we don't want to think about:


Lest we forget, as noted previously, the aging baby boomers are going to put a really bad crimp into the best laid plans of government.  Those of us that are boomers are already using more of the social network (i.e. health care) that our government supplies than we did a decade or two ago and, looking at the lives of our parents, we are likely to use more of the goodies that our government provides as the next decades pass.  Here's a little graph from the CBO showing just that:


Notice that pretty, little dark blue wedge "Effect of Aging" and how it adds about 4 percent of GDP to the cost of supplying health care and Social Security by 2035?  Can you imagine how wide that wedge will be by 2050 when the youngest of the baby boomers are in their mid-80s?

The CBO, as noted earlier in this posting, mentions briefly that the massive accrual of federal debt could have an upward impact on interest rates.  Let's take a look at the impact of rising interest rates on the entire scenario.  A study entitled "Projected Interest Payments on Federal Debt Balloon" by Veronique de Rugy a Senior Research Fellow at George Mason University, linked here, has a most interesting chart which shows the projected interest payments to the year 2084 from the CBO's alternative fiscal scenario as noted above.  In their analysis, the CBO assumes constant long-term interest rates at just below 5 percent.  In Ms. de Rugy's research, she uses the same budgetary data but changes the interest rate.  At an interest rate of 6 percent, the interest cost of the debt reaches 59.8 percent of GDP by the year 2084.  If the interest rate rises to 7 percent, the interest on the projected debt reaches 136 percent of GDP in 2084.  

Three more letters and two exclamation marks:  OMG!!

Back to the CBO report.  Here's a look at the debt situation as a percentage of GDP under the two scenarios:



Enough said.

Here is Congressional Budget Office's summary of the issues facing government from their report:

"Keeping deficits and debt from growing to unsustainable levels would require raising revenues as a percentage of GDP significantly above past levels, reducing outlays sharply relative to CBO’s projections, or some combina- tion of those approaches. Making such changes while economic activity and employment remain well below their potential levels would probably slow the economic recovery. However, the sooner that long-term changes to spending and revenues are agreed on, and the sooner they are carried out once the economic weakness ends, the smaller will be the damage to the economy from growing federal debt. Earlier action would require more sacrifices by earlier generations to benefit future generations, but it would also permit smaller or more gradual changes and would give people more time to adjust to them." (my bold)

President Obama, Senators and Congressmen/Congresswomen (and anyone else in government from any other country who cares): the horse has already left the barn.  It's likely already far too late to shut the door.

By the way, the interest on the debt for the first nine months of fiscal 2011 is $385,871,949,498.62. The interest owing for the first nine months of this year has already reached 93 percent of the interest owing for all of fiscal 2010 with over $110 billion owing for the month of June 2011 alone. 

Heaven help us if interest rates ever go back up to historical norms!

References:


14 comments:

  1. A Political Junkie:
    Thanks for providing this information.
    At least the interest on the "surpluses" in the Social Security and Medicare trust funds, are not a current budget expense.
    Rather, it is "paid" by issuing Treasury securities (additional debt, ouch)!
    From a paper entitled "Social Security: Why Action Should be Taken Soon," published by the Social Security Advisory Board in Dec. 2010, it states:
    Page 13 "The interest that accrues on Trust Fund bonds is paid out of general revenues. In addition, general revenues are used to redeem the securities held by the Trust Funds at maturity."
    This would be great if the budget was running a surplus, and there were "general revenues" available.
    Basically, what they are saying (or not saying) is that interest on the trust funds, and redeeming the principal and interest of the trust funds will be paid by increasing the debt held by the public.
    http://www.ssab.gov/Documents/Social_Security_Why_Action_Should_Be_Taken_Soon_PrePublication.pdf.
    Don Levit

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  2. Thanks Don. It looks like an interesting paper. Unfortunately, acting "sooner rather than later" may already be too late! I'm not certain if you've read Kotlikoff's book "The Coming Generational Storm" but it is along similar lines. If you don't mind, I may do a posting on the paper you recommended as an addendum to the posting I've already started on Kotlikoff.

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  3. Actually, I do have that book, but have just skimmed it.
    I have an E-mail "friend, " Scott Burns, who co-wrote the book with Kotlikoff.
    When you post on his blog, maybe mention I will try to visit him, since my daughter just started school in Sept. at Emerson, in Boston, where Kotlikoff lives.
    We planned to try to meet in October, at the parents' weekend, but I just did not have enough time.
    What is the web site for his blog?
    Don Levit

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  4. Don

    Here's his website:

    http://www.kotlikoff.net/

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  5. I can't believe any politicians will have the necessary gumption to make the painful changes. They'd lose the grey vote! I see a near future where the US government goes bankrupt from the medical costs of the babyboomers and we end up with numerous old people dying before they'd prefer, probably in pain. So the rest of us (yes even US citizens who don't even live in the US) will be legally plundered of our wealth (what little we have) to care for other people's relatives. Of course by the time I'm old and grey there won't be a medicare system (and I haven't been able to have children) so I'm praying one of my many nieces and nephews ends up wealthy and just happens to love me!

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  6. A Political Junkie:
    Thanks for the web site.
    Don Levit

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  7. Scary, sickening... And sadly a view that I've been seeing as happening to the US since Clinton was kicked out of office. Really, he cheated on his wife. Look at that raptor... I'd have done the same thing if I was in Bill's shoes! ..Not really, but it just isn't that big a deal when determining "Can this man bring the US into power?" The answer to that was an inescapable "yes!". Now with the surplus, the first the US had made in what, 50 years? More? down the drain and into the sewers thanks to Bush, Obama has to try and fix things... And it honestly looks like the US is about to be crushed under the weight of its own debt. Who knows, maybe Canada will be willing to buy you guys out for the same price as Newsweek was bought... a buck.

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  8. you wrote: under this scenario, they would rise to 4 percent of GDP (or one-sixth of federal revenues) by 2035."

    Isn't 4% = 1/25th ??

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  9. Maybe you could just shave a few of your nearly eight hundred oveseas miltary bases, stop killing brown people and generally grow-up a bit; even if it didn't postivedly effect your debt burden, it might make the world a better place; or would America rather be skint but tooled-up. (trans: tooled-up,UK slang, bristling with weapons)

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  10. @call me ishmael: this "brown" person writing back to you is grateful that there are many US military bases around the globe or else me and my children would continue to be oppressed in the nation we were once living in. GOD BLESS the USA and for the hope it brings to the world and to the death it brings to the enemies of freedom.

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  11. Malcolm

    It's 4 percent of GDP but one sixth of revenues - two entirely different things.

    Thanks for the comment.

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  12. It gets worse, the US has a "fiscal gap—the present value of all its future spending (including servicing its official debt) less all its future taxes of $202 trillion—almost 14 times GDP. Greece, by comparison, has a fiscal gap of about 11 times GDP. " Quote is from today's update to The Economist, the author of this quote is Laurence Kotlikoff. Other interesting comments from other economists are there as well.
    Luckily, the rest of my rant was lost in cyberspace, one didn't need to read it as I am a frustrated retired gov't employee who had to deal with the inanities of the planning, programming, budgeting, and execution system. The stories I could tell, but it would take a book length effort to explain and put into context so that the ramifications would be clear. It is highly complex and even most of the folks working in it didn't truly understand it, which made it even worse. Any simplistic view or statement just won't cover it. The budget issues have tendrils that reach in all sorts of directions and major effects are from areas you wouldn't even think of that have more influence that reason or facts.
    Bluntly, any hope of stemming the tide was lost with the election of Bush the Lessor, maybe even with the election of Reagon.

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  13. So what you are actually saying is that Obama and the demos are negligent to try to increase spending??!
    In the US just like the UK those that are there to make the decisions seem to be unable or unwilling to make changes of sufficient magnitude to have any real effect. I don’t accept that they are not aware of the extent of the problem.
    On the other hand most of the electorate are in denial and seem to be oblivious to the basic principles of compound interest. Result is prevention of any solution due to political inertia fueled by ignorance and denial of the problem. Of course no one in government wants to grasp the nettle, they would rather defer the problem to someone else.....at what point does that inaction become negligence?

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  14. Very fascinating!

    http://www.live-counter.com/compound-interest/

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