Order Code RS22354
December 27, 2005
CRS Report for Congress
Received through the CRS Web
Interest Payments on the Federal Debt: A
Primer
Thomas L. Hungerford
Specialist in Public Sector Economics
Government and Finance Division
Summary
Of the three broad categories of federal spending, the only category that cannot be
reduced by legislative action is net interest payments. Net interest payments accounted
for about 7% of federal spending between 1962 and the late 1970s. With the high
interest rates in the late 1970s and the large budget deficits in the 1980s, net interest
payments eventually rose to 15% of federal spending. The low interest rates combined
with budget discipline in the 1990s reduced net interest payments back down to 7% of
federal outlays by 2003. However, net interest payments have recently increased and
are projected to continue increasing in the near-term. This report will be updated
annually.
Federal spending is divided into three broad categories. First, discretionary spending
is provided and controlled by the annual appropriations acts and includes such things as
defense and education spending.1 Discretionary spending currently accounts for about
40% of federal outlays. Second, direct or mandatory spending is provided and controlled
by laws other than appropriation acts and includes spending for such programs as Social
Security and Medicare.2 Mandatory spending accounts for over half of federal outlays.
Lastly, net interest payments are interest payments on federal debt held by the public and
currently account for almost 7% of federal outlays.
In an effort to reduce spending, the FY2006 budget resolution (H.Con.Res. 95)
included reconciliation instructions to reduce mandatory spending by $35 billion over the
next five years. Congress ultimately voted to reduce mandatory spending by about $40
billion over five years. In addition, Congress enacted a 1% across-the-board reduction in
FY2006 discretionary spending. The only category of federal spending that cannot be
reduced by legislative action (barring default on the public debt) is net interest payments.
1 For more information on discretionary spending see CRS Report RS22128, Discretionary
Spending: Prospects and History, by Philip D. Winters.
2 For more information on mandatory spending see CRS Report RL33074, Mandatory Spending:
Evolution and Growth Since 1962, by Thomas L. Hungerford.
Congressional Research Service ˜ The Library of Congress

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While Congress cannot affect current net interest payments, congressional actions
on the budget will affect future interest payments. This report examines net interest
payments and the mechanisms through which Congress can affect net interest payments.
Federal Debt
Federal debt is composed of debt issued by the Treasury (Treasury securities) and
debt securities issued by other federal agencies (agency securities). At the end of
FY2005, total federal securities amounted to $7.9 trillion, of which only $23.6 billion
(0.3%) were agency securities. Federal debt is held either by the public (that is, private
investors) or in government accounts. Currently, about 42% of federal debt is held in
various government accounts. For example, the two Social Security trust funds currently
hold over $1.8 trillion in Treasury securities. The rest of the federal debt is held by the
public (foreign and domestic), including individuals, pension funds, banks, and other
investors.
Figure 1 shows the level of total federal debt and debt held by the public since 1962
as a percentage of gross domestic product (GDP). Both measures of debt fell as a
proportion of GDP between 1962 and the mid-1970s. Beginning in 1981, total federal
debt began to climb as tax cuts, increases in defense spending, and a recession increased
budget deficits. Total debt continued growing relative to GDP until the mid-1990s. As
budget deficits gave way to budget surpluses after 1997, and as the economy expanded,
federal debt fell as a percentage of GDP. The mild recession and the tax cuts in 2001
moved the federal budget back into deficit and federal debt consequently increased.
Between 1962 and 1982, total federal debt and debt held by the public followed
roughly parallel trends. After the mid-1980s, however, trends in total federal debt and
debt held by the public began to diverge. This was mainly due to changes in the Social
Security program enacted in 1983 which increased revenues and reduced the growth in
benefit payments. As a result, the Social Security program began to run surpluses (surplus
monies are invested in Treasury securities), increasing the share of federal debt held in
government accounts. The Congressional Budget Office’s (CBO) baseline projection
indicates that total federal debt and debt held by the public will continue to diverge over
the next 10 years.3
3 CBO’s baseline projection starts with Congress’s most recent budgetary decisions and then
assumes that no policy changes will be made over the projection period. For entitlement
programs CBO assumes that current laws will continue unchanged and by law assumes that
discretionary spending will grow at the rate of inflation throughout the projection period. For
revenues, CBO assumes that the provisions in the 2001 and 2003 tax cuts will expire on schedule,
and that more individuals will be subject to the alternative minimum tax (AMT). CBO’s
baseline is not intended to be a prediction of future budgetary outcomes. President Bush and the
Republican congressional leadership have proposed making the 2001 and 2003 tax cuts
permanent, and addressing the AMT. Consequently, future federal revenues could be
considerably lower than CBO’s baseline projection. See CBO, The Long-term Budget Outlook,
Dec. 2005.

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Figure 1. Total U.S. Federal Debt and Debt Held by the Public,
FY1962-FY2015
(as a percentage of GDP)
80
70
60
Total Federal Debt
50
t
n
e 40
rc
Pe
30
20
Publicly Held Debt
10
0
1962
1967
1972
1977
1982
1987
1992
1997
2002
2007
2012
Year
Source: OMB and CBO.
Interest Payments on the Federal Debt
In FY2005, total or gross interest on Treasury debt securities amounted to $352.4
billion — about 14% of federal outlays. However, not all of this flowed from the
Treasury to the public — $161 billion was credited to government accounts such as the
Social Security trust funds. The interest payments on the Treasury securities held in
government accounts do not represent funds or real resources available for spending.
Rather these interest payments are merely a bookkeeping entry transferring funds from
one government account to another.4
The upper line in Figure 2 shows the evolution of gross interest payments since
1962. Gross interest payments remained at about 7% to 8% of outlays until the late
1970s. After 1978, interest payments rapidly increased to reach almost 18% of outlays
by 1997. After 1997, gross interest payments fell as a percentage of outlays as interest
rates fell and the federal budget moved from deficit to surplus. When federal budget
deficits reappeared in 2002, gross interest payments began rising.
4 In essence, the interest payments are used to purchase more Treasury securities. While not
representing real resources available for current spending, the government will eventually have
to find real resources (by raising taxes or reducing spending) for the redemption of these
securities, under current law.

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Figure 2. Gross and Net Interest on Treasury Debt Securities,
FY1962-FY2015
(as a percentage of federal outlays)
20
18
Gross Interest Payments
16
14
12
t
n
e 10
rc
Pe
8
Net Interest Payments
6
4
2
0
1962
1967
1972
1977
1982
1987
1992
1997
2002
2007
2012
Year
Source: OMB and CBO.
Net interest payments are the component of gross interest payments that involves a
transfer of funds or real resources from the government to the public. The lower line in
Figure 2 shows the evolution of net interest payments since 1962. For the most part, net
interest payments followed the same basic trend as gross interest payments. However, the
gap between gross and net interest payments widened after the mid-1980s.5 As with gross
interest payments, net interest payments fell as a percentage of federal outlays when
federal debt declined in the late-1990s. Net interest payments began to increase in 2004
and CBO projects they will continue rising for at least the next five years, and, under
plausible scenarios, could continue rising indefinitely.6
5 The widening of this gap is due, in part, to the increases in the Social Security trust fund
resulting from the 1983 amendments to the Social Security Act. These amendments led to
increasing revenues to the Social Security program, and reduced the growth in benefits.
6 See CBO, The Long-term Budget Outlook, Dec. 2005.

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Determinants of Net Interest Payments
The primary determinants of net interest payments are (1) the interest rate or yield
on U.S. Treasury securities, and (2) the level of debt held by the public. Figure 3 shows
the evolution of net interest payments, debt held by the public, and the interest rate since
1967. The interest rate is the yield on five-year constant maturity U.S. Treasury bonds.
Both net interest payments and debt held by the public are expressed as a percentage of
GDP, and are indexed so that the value in 1967 is equal to one.7
Figure 3. Interest Rate, Net Interest Payments, and Debt Held by the
Public, FY1967-2004
3
15
Net Interest
(left axis)
2.5
Interest Rate
(right axis)
)
2
10
1
=
Pe
rcent
1.5
Index (1967
1
5
Debt Held by the
Public
0.5
(left axis)
0
0
1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003
Year
Source: OMB and Federal Reserve Board.
Net interest payments increased rapidly beginning in 1977 at about the same time
that interest rates increased dramatically (see Figure 3). Net interest payments continued
to increase after interest rates fell in the early 1980s because of the increase in debt held
by the public. The increase in debt held by the public was due to the large budget deficits
in the first years of the Reagan Administration and counteracted the effect of falling
interest rates on net interest payments. As both interest rates and debt held by the public
fell after 1997, net interest payments fell as a proportion of federal outlays.
The government can, to some extent, control the effective interest rate paid on its
debt by varying the maturity of its securities. The federal government issues both short-
term and long-term debt. The yield on Treasury securities varies with the maturity of the
7 The index is created by dividing the value in each year by the value in 1967. This is done so
that both series fit on the same graph.

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securities. Typically, short-term securities have a lower yield than longer-term securities,
and the yield curve, therefore, is upward sloping.8 Occasionally, the yield curve will
invert with longer-term securities having a lower yield than short-term securities, but this
happens neither often nor for extended periods.
A primary goal of debt management is to obtain the lowest borrowing cost over time.
Over the past 30 years, the mean maturity of marketable Treasury securities held by
private investors has varied between about three years and six years. Since 2000, the
range has narrowed to between five and six years. However, this apparent stability masks
changes in the types of securities issued. In 2001, for example, the Treasury stopped
issuing 30-year bonds.9 Although shorter-term Treasury securities tend to have lower
yields than longer-term securities, they also are more volatile. Consequently, the
financing costs of short-term securities can change dramatically over fairly short periods.
This volatility and uncertainty complicate efforts to obtain the lowest borrowing costs
over time.
Congressional actions affecting the budget deficit will affect federal debt, which, in
turn, affects future net interest payments. Budget deficits and federal debt can also affect
the interest rates on Treasury securities.10 Increasing federal debt will increase the supply
of Treasury securities. This will tend to push down the price and increase the yield of
these securities.11 Recent studies have estimated that increasing debt held by the public
by one percent of GDP will increase future interest rates by two to six basis points (0.02
to 0.06 percentage points).12 Thus budget deficits increase federal debt and future interest
rates, which in turn increase future net interest payments.
8 The yield curve is the relationship of the yield on securities and the maturity of those securities.
9 Treasury plans to issue 30-year bonds again beginning in February 2006.
10 The strength of the economy, inflation expectations, and the actions of the Federal Reserve
Board also have an important effect on interest rates.
11 There is an inverse relationship between the price of a bond and the yield of the bond.
12 See Eric Engen and R. Glenn Hubbard, Federal Government Debts and Interest Rates, National
Bureau of Economic Research, Working Paper no. 10681, Aug. 2004; William G. Gale and Peter
R. Orszag, “Budget Deficits, National Saving, and Interest Rates,” Brookings Papers on
Economic Activity, vol. 2004, no. 2 (2004), pp. 101-187; and Thomas Laubach, New Evidence
on the Interest Rate Effects of Budget Deficits and Debt, Board of Governors of the Federal
Reserve System, Finance and Economics Discussion paper no. 2003-13, May 2003.

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