- - Sunday, January 5, 2014


Despite the federal deficit’s recent decline, it remains large, and the nation’s growing debt threatens to quickly accelerate it to new heights.

During the past four years, the deficit has been historically high and federal interest rates historically low. Together, they have overshadowed the rapidly increasing federal debt. Now, with the deficit down from its heights and interest rates up from their lows, a looming menace is becoming clear: The federal government’s increasing debt has created the equivalent of a large, new entitlement-spending program in the form of debt-service costs.

No longer a peacetime record, the deficit still remains very large. The fiscal 2013 deficit came in at 4.1 percent of gross domestic product (GDP). While much lower than its 9.8 percent peak in 2009, it is also still much higher than either its 40-year average of 3 percent, calculated by the Congressional Budget Office, or the fiscal 2007 level of 1.1 percent — the last year before the recession. Had it not been for the large deficits of the previous four years, fiscal 2013’s rate would have been the highest since 1992.

Unsurprisingly, these high deficits have exploded the federal debt. Since fiscal 2007, the federal debt held by the public has more than doubled in absolute terms, rising from just above $5 trillion to just under $12 trillion at fiscal 2013’s close. It also increased sharply as a share of the nation’s economy, climbing from 35.1 percent of GDP to 72.1 percent, according to the Department of Treasury.

It is surprising, though, that the interest costs of this combination of rapidly increasing deficits and debt has been almost entirely muted by recent record-low interest rates.

According to the CBO, fiscal 2007’s net interest on debt held by the public was an enormous $237.1 billion. However, let’s look at what has happened since then: Despite the federal debt more than doubling in both nominal terms and relative to the economy, it was “only” $259 billion last fiscal year.

Rapid deficit and debt increases, but declining-to-flat debt-service costs, are more than an oddity. They obscure the looming debt threat to Washington’s budget and America’s economy. To get a sense of just how great this could become, it helps to put it into context:

Last year’s debt-service cost amounted to 1.6 percent of GDP — lower than the 1.7 percent it was in fiscal 2007. According to the CBO, the federal net interest cost has averaged 2.2 percent of GDP during the past 40 years. Once we see a reversion to the long-term average as interest rates rise, we can expect federal debt service to rise, too. During fiscal 2013, had the rate surpassed its 2.2 percent 40-year average by 0.6 percent of GDP, the deficit would have been 4.7 percent — its highest level since 1986, when the federal deficit was fueled by a successful push to end the Cold War.

Real as that problem is, federal debt-service costs will not simply return to that level, because the federal debt is much greater now. The federal debt’s 40-year average is 38 percent of GDP, but last fiscal year, it was almost double at 72.1 percent.

Future debt-service costs will also climb. Raising the 40-year average federal debt-service cost of 2.2 percent by the same factor as the federal debt’s hike would boost federal debt-service costs to a whopping 4.2 percent of GDP — 2.6 percent higher than it was last year.

Combining these two adjustments — raising federal debt-interest costs to their 40-year average and then adjusting it for the federal debt’s increase — would add 2.6 percentage points of GDP to last fiscal year’s deficit, raising it to an extremely high 6.7 percent of GDP. At that level, the federal deficit would be the highest of any year in the last 40 — were it not for those of the previous four years.

Similarly, converting a federal interest cost of 4.2 percent of GDP in fiscal 2013 into nominal dollars would equal $694 billion, which falls between the two largest federal entitlement programs — Medicare ($495 billion) and Social Security ($803 billion).

In effect, Washington has created the equivalent of a new entitlement-spending program, of which we have only seen this large iceberg’s tip.

Before Washington makes too much noise celebrating the deficit’s decline, it had better be careful to not wake the real monster still slumbering: federal debt-service costs. Once they begin to stir, the federal deficit and the debt will accelerate again very quickly.

J.T. Young served in the Treasury Department and the Office of Management and Budget from 2001 to 2004 and as a congressional staff member from 1987 to 2000.



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