U.S. Interest Costs Hit Record $1 Trillion, Risking Debt Snowball

Manage, for now

“Somehow we’re getting there, even with interest rates rising,” Phillip Swagel, director of the Congressional Budget Office, said at an Oct. 8 event in Minneapolis. At the same time, he warned that the deterioration of fiscal dynamics makes the country increasingly vulnerable. “Every time there is a negative shock, interest rates rise for whatever reason,” there can be a “turbocharger effect.”

In this scenario, the shock of rising rates “fuels the deficit, fuels the debt, and passes interest rates through the economy,” said Swagel, whose agency predicted in February that the debt-to-GDP ratio would reach a record topping 106% in 2030. The former Treasury official also said that while he has been delivering the same budget message for a long time, market participants have been more interested in the past two years.

Interest costs are now one of the three largest items on the list of federal spending, having more than doubled since 2022 alone. They are surpassed only by Social Security and Medicare, the giant federal programs for older Americans, whose costs rise each year as the number of beneficiaries increases by millions. The Department of Defense and Medicaid round out the top five.

The last time interest costs as a percentage of debt were near current levels, U.S. policy prepared for the challenge. President George HW Bush reneged on his promise not to impose new taxes by signing a package of tax increases in 1990, just before the interest-cost ratio peaked. His successor, Bill Clinton, increased the levies further in 1993.

Waiting for a catastrophe?

The end of the Cold War was also marked by a decline in defense spending, thereby strengthening the budgetary situation. At the end of the 1990s, the resumption of economic growth, linked to the diffusion of the Internet and personal computing, propelled incomes.

Today, Bessent and other Trump administration officials are touting the artificial intelligence boom as a growth booster that will help reduce debt levels. Budget experts, however, are skeptical. Spending on defense and social programs looks set to continue to rise, while GDP gains likely won’t be fast enough to sufficiently fuel revenue, they say.

“The problems are only getting worse, so we shouldn’t be debating whether to wait for disaster to happen — we should be working on it now,” said Brett Loper, executive vice president of policy at the Peterson Foundation. “It’s going to be very difficult to get out of this problem.”

The increase in net interest payments this year, to $81.4 billion, could be eclipsed if rates continue to rise. The Fed is expected to raise its benchmark overnight rate at least once more — currently between 3.75% and 4% — which would drive up the cost of short-term debt that Bessent increasingly favors.

A 100 basis point rise in the yield curve would increase interest costs by $310 billion in 2027, according to calculations by TD Securities.

“I don’t think a fiscal crisis is imminent, we still have a pretty strong economy,” said Karen Dynan, an economics professor at Harvard University who worked at the Treasury during the Obama administration. And rates still haven’t returned to the levels of three or four decades ago, she noted.

At the same time, “with debt this high, the net interest payments are really important – they will lead to a debt explosion,” she said. “Increasing interest rates and interest payments relative to GDP could spur public opinion into action.”

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