The budget and the federal debt
How does the budget deficit or surplus relate to federal debt?
When Congress makes budgetary decisions, it is also indirectly making decisions about borrowing and therefore the level of debt held by the public. The yearly change in debt held by the public is approximately equal to the budget surplusThe amount by which the government's revenues exceed its spending in a given period, usually a fiscal year. or deficitThe amount by which the government's spending exceeds its revenues for a given period, usually a fiscal year.. When the budget is in deficit, the government borrows from the public; when the budget is in surplus, the government can reduce the amount of debt held by the public. Thus, debt held by the public generally represents the total of all cash deficits minus all cash surpluses accumulated over time.
How do trust fund surpluses or deficits affect debt?
Trust fund total surpluses add to debt held by government accounts, but only cash surpluses reduce the need for the federal government to borrow from the public. While federal debt is held as an asset by trust funds with cash surpluses, the cost of some programs like Social Security Disability Insurance and Medicare Hospital Insurance exceeds their revenues and they are expected to deplete their assets in the coming years. In addition, the Social Security Old-Age and Survivors Insurance program has historically run large cash surpluses that helped reduce the government's need to borrow from the public to finance other federal government activities. However, Social Security has paid more in benefits than it has received in taxes since fiscal year 2010, thereby contributing to the government's borrowing needs. The Social Security Trustees project that the program will run persistent cash deficits over the next 75 years. For additional information about trust funds, see Federal Trust and Other Earmarked Funds: Answers to Frequently Asked Questions.
How does federal debt affect the federal budget?
The federal government—like other borrowers—pays interest on its debt. The federal debt affects the federal budget through the level of interest spending. Interest spending—which depends on the amount of debt and the interest rate on that debt—cannot be changed directly. Both additional borrowing and higher interest rates increase the amount of interest paid. Consequently, interest spending can absorb resources that could be used instead for other national priorities.
Spending on net interestPrimarily interest on debt held by the public. The government also earns some interest from various sources and pays interest for purposes other than borrowing from the public. These amounts are only a small portion of net interest and, taken together, slightly reduce its total. as a percentage of federal spending has fluctuated over time, exceeding 10 percent from 1947 through 1951 and again from 1981 through 2001. In the past, interest payments contributed to deficits and helped fuel rising debt levels. Rising debt, in turn, raised interest costs in the budget, and the federal government increased debt held by the public to finance these interest payments. This has been called the "vicious cycle."
Today's relatively lower interest rates have lessened this pressure on the budget, despite the recent increase in debt held by the public. However, the Congressional Budget Office (CBO) and others project that interest rates will rise in the long term, increasing interest costs on the debt and increasing pressure on the budget.
GAO analysis of data from the Office of Management and Budget, Budget of the United States Government for Fiscal Year 2017-Historical Tables; and the Congressional Budget Office, Budget and Economic Outlook: 2017 to 2027 (January 2017, Supplemental Data).
Treasury regularly refinances portions of the government's outstanding debt and issues more debt at market interest rates to finance deficit spending. Consequently, the amount that the federal government spends on interest on its debt is directly tied to those interest rates. Under CBO's January 2017 baseline budget projections, debt held by the public would be 89 percent of GDP in 2027 and spending on net interest would rise from $241 billion in 2016 to $768 billion (or 2.7 percent of GDP) in 2027. CBO notes that if interest rates are 1 percentage point higher than the rates assumed in CBO’s baseline budget projections, the government’s higher interest costs would add about $1.6 trillion to the cumulative budget deficit over the 10-year period. Conversely, if interest rates were lower than CBO projects, deficits would be lower.
What are the different measures of federal interest?
Just as there are two main categories of debt, there are two types of interest in the budget.
- Gross interestEssentially represents interest on all Treasury debt securities, including interest on debt held by the public and interest credited to government trust funds and other government accounts that hold federal debt. paid on all outstanding federal debt—both debt held by the public and debt held by government accounts.
- Net interestPrimarily interest on debt held by the public. In addition to interest on debt held by the public, the government also earns some interest from various sources, such as interest paid on federal student loans, and pays interest for purposes other than borrowing from the public. These amounts are only a small portion of net interest and, taken together, slightly reduce its total. paid primarily on debt held by the public. This interest is part of current spending by the government and represents the cost of making payments on the debt.