December 14, 2010
The past few years have seen a sharp rise in the debt of the federal government. At the end of fiscal year 2008, debt held by the public amounted to $5.8 trillion--equal to 40 percent of the nation's annual economic output (gross domestic product, or GDP), a little above the 40-year average of 35 percent. Since then, debt held by the public has shot upward, surpassing $9 trillion by the end of fiscal year 2010--equal to 62 percent of GDP, the highest percentage since shortly after World War II. The surge in debt stems partly from lower tax revenues and higher federal spending related to the recent severe recession and turmoil in financial markets. However, the growing debt also reflects an imbalance between spending and revenues that predated those economic developments.
At the same time, a sharp drop in interest rates has held down the amount of interest that the government pays on that debt. In 2010, net interest outlays totaled $197 billion, or 1.4 percent of GDP--a smaller share of GDP than they accounted for during most of the past decade.
The Congressional Budget Office (CBO) projects that, under current law, debt held by the public will exceed $16 trillion by 2020, reaching nearly 70 percent of GDP. CBO also projects that interest rates will go up. The combination of rising debt and rising interest rates is projected to cause net interest payments to balloon to nearly $800 billion, or 3.4 percent of GDP, by 2020.
Many other outcomes are possible, however. If, for example, the tax reductions enacted earlier in the decade were continued, the alternative minimum tax was indexed for inflation, and future annual appropriations remained the same share of GDP that they were in 2010, debt held by the public would total nearly 100 percent of GDP by 2020. Interest costs would be correspondingly higher.
This CBO study describes historical trends in borrowing by the federal government and the interest the government pays on that borrowing. The study takes an in-depth look at the most commonly used measure of the government's debt--debt held by the public--and also discusses several other measures of the debt, such as debt held by the public net of financial assets, gross federal debt, and debt subject to limit. In addition, the study examines the government's net interest costs and the types of transactions that generate interest payments and collections.
Debt Held by the Public
To finance the government's activities, the Treasury issues numerous types of securities that vary in their maturity, how they are sold, and how their payments are structured. Marketable securities--bills, notes, bonds, and inflation-protected securities--are auctioned at regular intervals during the year and accounted for nearly 95 percent of outstanding debt held by the public at the end of 2010. Nearly two-thirds of that marketable debt was in Treasury notes, which have an original maturity of 2 to 10 years.
A small percentage of debt held by the public is in the form of nonmarketable securities, which cannot be resold by the original purchasers. Those securities include savings bonds, securities issued to state and local governments, and securities used for investments of the government's Thrift Savings Plan (a retirement savings program for civil service employees and members of the uniformed services).
The government's net borrowing for each year (that is, the new cash it must raise, over and above the amount required to pay off maturing securities) is determined largely by the size of the federal deficit. However, a number of other factors--collectively labeled other means of financing and not directly included in budget totals--also affect the amount of debt that the government issues. Those factors include changes in the government's cash balances and the cash flows of federal credit programs (mostly programs that provide loans and loan guarantees).
Many investors consider federal debt to be an attractive investment, in part because it is essentially free of any risk of default. At the end of 2010, domestic entities owned about 53 percent of the outstanding public debt, and foreign entities owned about 47 percent. Central banks and private entities in China, Japan, and the United Kingdom are the largest foreign investors.
Other Measures of Federal Debt
In addition to debt held by the public, a number of other measures of federal debt are used for various purposes. Debt held by the public net of financial assets is a measure that reflects the fact that the government affects financial markets not only by borrowing but also by acquiring financial assets. Those assets affect the government's financial condition: If sold, the proceeds could be used to pay down a portion of the federal debt; if retained by the government, they will generate inflows from interest, dividends, and repayments of principal that will reduce the government's future borrowing needs.
Debt held by the public net of financial assets is calculated by subtracting from debt held by the public the value of assets the government has acquired through its various activities in the credit markets (such as loans made by federal programs) and through its efforts to address the recent financial crisis (such as preferred stock in financial institutions), as well as its cash balances. At the end of 2010, debt net of financial assets totaled $8.0 trillion--$1.0 trillion less than debt held by the public and 55 percent of GDP (compared with 62 percent of GDP when financial assets are not taken into account). Debt held by the public net of financial assets provides a more comprehensive picture of the government's financial condition and its overall impact on credit markets than debt held by the public, but calculating it is not straightforward because neither the universe of such assets nor the method for valuing them is well defined.
Assessing the government's overall financial condition requires accounting not only for debt that the government has already incurred (and financial assets it has acquired) but also for commitments the government has made for the future. Debt held by the public, with or without an adjustment for the government's financial assets, does not account for such future obligations. One useful barometer of the future fiscal situation is projections of changes in debt held by the public relative to GDP; that measure indicates whether the government's participation in credit markets is expected to grow faster or slower than economic output. Another useful gauge is the fiscal gap, which measures the immediate change in spending or revenues that would be necessary to keep the projected debt-to-GDP ratio the same at the end of a given period as at the beginning of the period. The fiscal gap quantifies the projected long-term shortfall of revenues relative to outlays in present-value terms--that is, as a single number that describes a flow of future revenues or outlays in terms of an equivalent lump sum received or spent today. These forward-looking measures are not addressed in this study but are used extensively in other CBO publications.
Gross debt, which comprises federal debt held by the public plus Treasury securities held by federal trust funds and other government accounts, is sometimes used to evaluate the government's overall fiscal situation. At the end of 2010, gross federal debt totaled $13.5 trillion--the $9.0 trillion in debt held by the public plus $4.5 trillion in debt held by government accounts. More than half of the latter amount is held by the Social Security trust funds. Because those trust funds and other government accounts are part of the federal government, transactions between them and the Treasury are intragovernmental; that is, the government securities in those funds are an asset to the individual programs but a liability to the rest of the government. The resources needed to redeem the government securities in the trust funds and other accounts in some future year must be generated from taxes, income from other government sources, or borrowing by the government in that year.
Gross debt is not a good indicator of the government's fiscal condition, however (nor is debt subject to limit, the amount of federal debt that is subject to the overall limit set in law and is roughly equal to gross debt). The value of Treasury securities held by trust funds and other government accounts measures only some of the commitments the government has made for the future, and it includes some amounts that may not represent future obligations at all. Moreover, because those securities represent internal transactions of the government, they have no direct effect on credit markets.
Interest Payments and Receipts
The government pays and collects interest in various ways. Its net interest outlays are equal to the interest it pays minus the interest it receives. Net interest outlays are dominated by the interest paid to holders of the debt that the Treasury issues to the public. Although the Treasury also issues debt to trust funds and other government accounts, the payment of interest to those accounts is an intragovernmental transaction that has no effect on net interest outlays or on the budget deficit.
The federal government's interest payments depend primarily on interest rates and the amount of debt held by the public. Other factors, such as the rate of inflation and the maturity structure of outstanding securities, also affect interest costs (for example, long-term bonds generally carry higher interest rates than do short-term bills). Interest rates are determined by a combination of market forces and the policies of the Federal Reserve. Debt held by the public is determined mostly by cumulative budget deficits, which depend on policy choices about spending and revenues and on economic conditions and other factors.
Although the federal government has increased its net borrowing by more than $3 trillion in the past two years, net interest costs dropped from $253 billion in 2008 to $197 billion in 2010 because of remarkably low interest rates. The amounts of net interest shown in the budget include interest paid on all Treasury securities ($413 billion in 2010), minus the portion of that interest that is received by trust funds ($186 billion in 2010) and the net amount of other interest received by the government ($30 billion in 2010). The last category consists primarily of net receipts to the Treasury from the financing accounts for federal loan programs (those accounts are not included in the federal budget).
In CBO's most recent projections, which assume that current laws remain the same, annual deficits decline from the $1.3 trillion recorded in 2010, but the cumulative deficit from 2011 through 2020 exceeds $6.2 trillion. Borrowing to finance that deficit--in combination with an expected rise in interest rates--would lead to a fourfold increase in net interest payments over the next 10 years, from $197 billion in 2010 to $778 billion in 2020. As a percentage of GDP, net interest outlays would more than double during that period, rising from 1.4 percent to 3.4 percent.