Interest Payments on the Federal Debt: A Primer

Interest Payments on the Federal Debt: A Primer

Interest Payments on the Federal Debt: A
Primer
Thomas L. Hungerford
Section Research Manager
April 15, 2010
Congressional Research Service
7-5700
www.crs.gov
RS22354
CRS Report for Congress
P
repared for Members and Committees of Congress

Interest Payments on the Federal Debt: A Primer

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. Low interest rates kept net
interest payments low to 2009. However, net interest payments are projected to increase
dramatically over the next 10 years. This report will be updated annually.
Congressional Research Service

Interest Payments on the Federal Debt: A Primer

Contents
Federal Debt ............................................................................................................................... 1
Interest Payments on the Federal Debt......................................................................................... 3
Determinants of Net Interest Payments........................................................................................ 4

Figures
Figure 1. Total U.S. Federal Debt and Debt Held by the Public, FY1962-FY2020........................ 2
Figure 2. Gross and Net Interest on Treasury Debt Securities, FY1962-FY2020 .......................... 3
Figure 3. Interest Rate, Net Interest Payments, and Debt Held by the Public, FY1967-
FY2009.................................................................................................................................... 5

Contacts
Author Contact Information ........................................................................................................ 6

Congressional Research Service

Interest Payments on the Federal Debt: A Primer

ederal spending is divided into three broad categories. First, discretionary spending is
provided and controlled by the annual appropriations acts and includes such things as
F defense and education spending.1 Discretionary spending currently accounts for about 35%
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 5% of federal outlays. The Congressional Budget Office (CBO) in their baseline
projection has net interest payments growing to almost 14% of federal outlays by FY2020.
In February 2010, President Obama created the bipartisan National Commission on Fiscal
Responsibility and Reform. The Commission’s task is to identify policies that will improve the
fiscal situation in the medium term and achieve fiscal sustainability in the long term. The policies
could involve changes to the growth of entitlement spending, increases in revenues, and decreases
in other spending. The recommendations of the Commission could serve as a basis for legislation
to reduce federal deficits by increasing taxes and reducing spending. The only category of federal
spending that cannot be reduced by legislative action (barring default on the public debt) is net
interest payments.
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 2009, total federal securities
amounted to more than $12 trillion, of which only $23.5 billion (less than 0.2%) were agency
securities. Federal debt is held either by the public (that is, private investors) or in government
accounts. Currently, about 36% of federal debt is held in various government accounts. For
example, the two Social Security trust funds currently hold about $2.5 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.

1 For more information on discretionary spending see CRS Report RL34424, Trends in Discretionary Spending, by D.
Andrew Austin and Mindy R. Levit.
2 For more information on mandatory spending see CRS Report RL33074, Mandatory Spending Since 1962, by D.
Andrew Austin and Mindy R. Levit.
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Interest Payments on the Federal Debt: A Primer

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. CBO’s baseline projection
indicates that total federal debt and debt held by the public will continue to diverge over the next
10 years.3
Figure 1. Total U.S. Federal Debt and Debt Held by the Public, FY1962-FY2020
(as a percentage of GDP)
120
100
80
t
Total Federal Debt
60
Percen
40
Publicly Held Debt
20
0
1962 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 2010 2014 2018
Year

Source: OMB and CBO.

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). Furthermore, the baseline
projection does not include the budgetary effects of any new stimulus legislation. CBO’s baseline is not intended to be
a prediction of future budgetary outcomes. See CBO, The Budget and Economic Outlook: Fiscal Years 2010 to 2020,
January 2010.
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Interest Payments on the Federal Debt: A Primer

Interest Payments on the Federal Debt
In FY2009, total or gross interest on Treasury debt securities amounted to about $383 billion—
about 11% of federal outlays. However, not all of this flowed from the Treasury to the public—
about $200 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.
Figure 2. Gross and Net Interest on Treasury Debt Securities, FY1962-FY2020
(as a percentage of federal outlays)
25
20
Gross Interest Payments
15
t
Percen 10
Net Interest Payments
5
0
1962
1967
1972
1977
1982
1987
1992
1997
2002
2007
2012
2017
Year

Source: OMB and CBO.

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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Interest Payments on the Federal Debt: A Primer

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 but leveled out because of falling interest rates. Additionally,
net interest payments fell dramatically in 2009 due to very low interest rates. Large budget
deficits in 2009 and 2010, however, will lead to rising net interest payments for the next five to
six years.6 CBO projects that, under plausible scenarios, net interest payments could continue
rising indefinitely.7
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.8
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 percentage of GDP and 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 securities. Typically, short-term
securities have a lower yield than longer-term securities, and the yield curve, therefore, is upward
sloping.9 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.

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 CBO projects that the deficit will be more than $1,300 billion in 2010 and $980 billion in 2011. See CBO, Budget and
Economic Outlook, January 2010.
7 See CBO, The Long-term Budget Outlook, June 2010.
8 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.
9 The yield curve is the relationship of the yield on securities and the maturity of those securities.
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Interest Payments on the Federal Debt: A Primer

Figure 3. Interest Rate, Net Interest Payments, and Debt Held by the Public,
FY1967-FY2009
3
15
Net Interest
(left axis)
2.5
Interest Rate
(right axis)
2
10
1)
Per
1967=
cen
1.5
t
ex (
d
In
1
5
Debt Held by the
Public
0.5
(left axis)
0
0
1967
1971
1975
1979
1983
1987
1991
1995
1999
2003
2007
Year

Source: OMB and Federal Reserve Board.
A primary goal of debt management is to obtain the lowest borrowing cost over time.10 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.11 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.12 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.13 Recent studies have
estimated that increasing debt held by the public by one percent of GDP will increase future

10 See CRS Report RL34682, Federal Debt Management: Concepts, Options, and Policies (1945-2008), by James M.
Bickley.
11 Treasury began issuing 30-year bonds again in February 2006.
12 The strength of the economy, inflation expectations, and the actions of the Federal Reserve Board also have an
important effect on interest rates.
13 There is an inverse relationship between the price of a bond and the yield of the bond.
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Interest Payments on the Federal Debt: A Primer

interest rates by two to six basis points (0.02 to 0.06 percentage points).14 Thus budget deficits
increase federal debt and future interest rates, which in turn increase future net interest payments.

Author Contact Information

Thomas L. Hungerford

Section Research Manager
thungerford@crs.loc.gov, 7-6422

14 See Eric Engen and R. Glenn Hubbard, Federal Government Debts and Interest Rates, National Bureau of Economic
Research, Working Paper no. 10681, August 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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