December 14, 2010
Recently, the federal government has been recording the largest budget deficits, as a share of gross domestic product (GDP), since the end of World War II. As a result of those deficits, the amount of federal debt held by the public has soared—surpassing $9.0 trillion at the end of fiscal year 2010 and equal to 62 percent of GDP. The interest the government pays on that debt is currently low by historical standards as a percentage of GDP but is expected to grow rapidly over the next several years as interest rates rise. In response to a request from the Senate Budget Committee, CBO prepared a study providing background material on federal debt and interest costs.
Debt held by the public consists mostly of securities that the Treasury issues to raise cash to fund the activities of the government, including the securities sold to pay off maturing securities. The amount the Treasury borrows or redeems is determined primarily by the budget deficit or surplus in a given year. CBO projects that, under current law, debt held by the public will surpass $16 trillion by 2020, reaching nearly 70 percent of GDP. 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.
The Treasury issues numerous types of securities differing in their maturity, how they are sold, and how their payments are structured. At the end of the third quarter of 2010, domestic entities owned about 53 percent of the outstanding public debt, and foreign entities (mostly in China, Japan, and the United Kingdom) owned about 47 percent.
Some of the debt incurred by the government has gone towards the acquisition of financial assets through various credit market activities (such as loans made by federal programs) and through efforts to address the recent financial crisis. Those assets affect the government’s financial condition: If sold, the proceeds could be used to pay down the federal debt; if retained, they will generate inflows that will reduce future borrowing needs. Debt held by the public net of financial assets takes account of such assets by subtracting their value from debt held by the public. Debt net of financial assets is currently about $8 trillion, roughly $1 trillion less debt held by the public, CBO estimates.
Other measures sometimes used to measure the government’s fiscal condition are gross debt and debt subject to limit, which differ only slightly from each other. Both comprise federal debt held by the public plus Treasury securities held by federal trust funds and other government accounts. Neither is a good indicator of the government’s overall fiscal condition, however.
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, of which more than half is in the Social Security trust funds. The balances in trust funds have accrued because income associated with those programs has exceeded the expenses; when that happens, the surplus cash flow is used to finance the government’s ongoing activities, and the trust fund is credited with a corresponding amount of Treasury securities. Although trust funds have an important legal meaning, in that they may constrain the amount a program can spend, they are essentially an accounting mechanism and have little relevance in an economic or budgetary sense. The value of Treasury securities held by trust funds and other government accounts measures only some of the commitments the government has made, and it includes some amounts that may not represent future obligations at all.
The Congress has traditionally placed a limit on the amount of debt the Treasury can issue. The “debt ceiling,” which applies to debt subject to limit, is quite important from a legislative perspective, in that it can only be raised by law. CBO estimates that the debt ceiling, which was boosted to $14.294 trillion in February 2010, will be reached in the next several months.
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. In CBO’s August projections, which assume that current laws governing spending and revenues remain the same, borrowing to finance projected deficits, in combination with an expected rise in interest rates, leads to a fourfold increase in net interest payments over the next 10 years, from $196 billion in 2010 to $778 billion in 2020. Larger deficits would result in even greater interest costs.
This study was prepared by Jared Brewster and Amber Marcellino of CBO’s Budget Analysis Division.