November 26, 2023

by Stephen Stofka

This week’s letter is about the federal interest paid on the country’s debt. Why does the U.S. pay more on its debt than other advanced economies? In the second quarter of this year, federal government paid 20% of its revenue in interest, almost three times the average 7.34% percentage of similar countries. High interest payments crowd out spending in other areas. They spark even more debates about the debt itself which is now 120% of GDP. This added interest expense exacerbates animosities in a country that is already fractured by divided perspectives and priorities.

In the second quarter of 2022, before the Fed began to raise rates, the federal government paid 13.6% of its revenues in interest (I/R) to service the debt. That was 6% less than the percentage in 2023 and represented $280 billion, more than twice the $128 billion spent in 2022 for the SNAP (food stamp) program. The higher interest payments, however, were about the same as the 50-year average I/R of 19% (median = 17.8%). In 2021, the 27 countries of the Euro area reported to the World Bank that they paid 3.11% of their revenues in interest (see note below).

Over the past fifty years, the federal government has collected about 20% of GDP in taxes. In the chart below, I have added both averages to the chart of federal interest payments as a percentage of revenue. The average revenue is almost identical to the median so this average is representative of a variety of economic conditions and policy responses over the long term.

As an approximation, the interest expense is 20% of revenue and revenue is 20% of GDP so interest expense has averaged 4% of GDP. However, neither the public nor policymakers are accustomed to average. For two decades, the Fed has kept interest rates low to accommodate economic recovery after the dot-com bust, 9-11, the financial crisis, the slow recovery from that crisis and the Covid-19 pandemic.

The pandemic simulated several critical conditions of a large scale war and the inflation that followed was typical of those inflationary periods following wars. I will cover that in next week’s letter. To curb an accelerating inflation, the Fed began to systematically raise rates from zero in the spring of 2022. In six months it raised rates by 2%, a rapid change that was six times faster than the period from late 2015 to early 2019 when the Fed gradually raised rates by the same 2%. By early 2023, the Fed raised rates an additional 2% within six months.

As a consequence of the higher rates, the government has paid higher interest rates on its debt. (The reasons for that are complex). We have become so accustomed to “easy money” and lower interest rates that the sudden increase in interest payments has caught the attention of both the public and policymakers. Will this further fracture political sentiment ahead of the 2024 elections?

At the beginning of this letter I mentioned divided perspectives and priorities. What are they?  Some give priority to the social programs that promote individual citizen welfare as essential to a general welfare. Their opposition may deride them as socialists but they are more properly called institutionalists because they champion a lot of control and planning by a central government to achieve that welfare. Those who oppose institutionalist policies also care about individual welfare but think that well-intentioned bureaucrats in government can cause more damage to the general welfare than they repair. These might properly be called marketists who believe that the price system distributes resources in an efficient and sustainable manner.  They respond that a centrally planned economy creates moral hazard, rewarding individual needs instead of personal hard work, planning and integrity.

Institutionalists label marketists as capitalists or plutocrats and accuse them of being mean-spirited and driven only by profit and self-interest. Vulnerable communities do not have the resources to help themselves, the institutionalists argue. Marginalized communities need to draw from a central funding pool. They must overcome decades of legal policies that disenfranchised them to benefit other groups. Marketists respond that profits reward people for taking risks. The willingness to accept risk is a key component of technological innovation that benefits all of society.

Interest payments have nudged aside defense spending to become the third largest percentage of federal receipts. The top category is health insurance like Medicare, Medicaid, CHIP and payments under the ACA which take up 30% of federal receipts (see note below). Social Security comes in second. Cuts to either of these programs have been a “hot rail” for conservative politicians. Everyone in Congress talks about cuts to defense spending but not in their district because it supports the local economy. The issue of rising interest payments and the federal debt is a safe one for politicians of both parties to run on in the upcoming election. According to Open Secrets, $14.4 billion was spent on the 2020 election, double the spending of the 2016 election. As candidates complain about excess spending, voters might consider why the major parties will spend about $100 for each of the votes in this coming election (notes below). I would call that excess spending.

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Photo by Joshua Woroniecki on Unsplash

Keywords: health care, ACA, Social Security, Medicare, defense spending, interest payments

Health Care Note: The health care programs are 24% of the federal budget including deficits, according to an analysis by the Center on Budget and Policy Priorities.

Election Spending: $14,400 million / 160 million voters ≈ $86 per voter in the 2020 election.

World Bank data: https://data.worldbank.org/indicator/GC.XPN.INTP.RV.ZS?end=2021&start=1972&view=chart. You can download an Excel file at https://api.worldbank.org/v2/en/indicator/GC.XPN.INTP.RV.ZS?downloadformat=excel to view interest payments for countries and regions dating back several decades.