Interest on the debt: Easily affordable in a growing economy

Based on my daily sampling of the headlines, I’m convinced that one of the top two most misunderstood aspects of our fiscal budget is “interest on the debt” (…the other being the nature of the debt principal itself). 

Conventional wisdom says interest on the debt is a “waste of money that buys us nothing.”  Politicians hammer away at that emotional theme day in and day out; here’s a recent example from the New York Times:

We are borrowing large sums from foreigners, leaving a legacy of debt, paying more than $1,600 per family in taxes just to cover the interest on the debt...

But conventional wisdom is so, so wrong about that, it’s hard for me to decide where to start with the rebuttal.  So I’ll tackle one important aspect in this post, with more to come in future posts. 

This post examines the question, “Can our nation afford the interest on its debt?”  The short answer: Yes, we can easily afford it today; net interest on the debt requires less than 10% of today’s tax receipts, far lower than the mid-1990s when interest consumed more than 15% of tax receipts. 

[Note: It’s important to isolate the question of today’s situation from the question of what the future situation might be.  Present and past interest affordability is a fact-based debate; future affordability depends on someone’s assumption, usually hidden, about what future growth rates will be.  If we can’t agree on the goodness or badness of the facts about today’s situation, how can we possibly agree on speculations about many possible future situations?]

How is it possible that interest payments, which have been growing and growing and growing, are easier to pay today than a decade ago?  Think about that a minute, then see if the following animated graphic yields any clues.  (Interest Payments are shown in red.)

Important: Click on this graphic to see the dynamic effects of growth.

Here’s why interest payments are easier to afford today than a decade ago:

•  Total dollars of interest are a result of two things: the publicly-held debt principal on which we must pay interest, and the interest rate we must pay on that principal;
•  Either an increase in the debt or an increase in interest rate the market demands for treasury securities will increase the dollars of interest we must pay out; conversely, a decrease in interest rates decreases the interest payout requirement;
•  An increase in the size of our economy increases the tax revenues the government takes in;
•  An increase in tax revenues makes it easier to pay any given amount of interest on the debt;
•  Not only have interest rates decreased since the mid-1990s, but recent-years’ GDP growth has resulted in tax revenues growing at a faster pace than the publicly-held debt has been growing;
•  Because interest payments have been growing more slowly than tax revenues, it now takes a smaller portion of tax revenues to pay the interest. 

Why won’t our politicians talk to us about growth-friendly policies?
With just a little bit of thought, it should be obvious that one of the two primary keys to this whole situation is the growth rate of our economy (the other key being interest rates).  Why, then, does this logic seem to elude almost 100% of our politicians?  I can only come up with two possibilities: (1) they just don’t understand it; or worse, (2) they do understand it, but have decided that the growth question would open up a can of worms and complicate their political talking points too much; keeping the debate oversimplified vastly simplifies the tasks of political sloganeering and opponent-demonizing. 

Ignorance or dishonesty, which is it?  I lean toward the former, but I don’t rule out the latter.  In any case, we should all keep reminding ourselves what “economic growth” means: it means that the grand total of my annual income, your annual income, and the annual incomes of our family members, friends, and fellow citizens is growing in real terms.  That’s the primary component of “real GDP growth”—and it’s the key to this whole question.  It’s really too bad our politicians are ignoring that all-important aspect of our economy. 

-------------------------------------------------------------
Tickler for future posts on this topic:

Do you know anyone who is making payments on a car loan or a home mortgage?  If so, ask them if they think the interest portion of those payments “buys them nothing.”  And if so, then why did they agree to the loan in the first place? 

That should lead to some interesting conversation.

Comments

[Aaron]

If government investment that increases debt is always bad thing, then consider the Louisiana Purchase:

"The cost of the purchase was to be $15 million dollars; a sum that increased the United States public debt by slightly over 20%."

From wikipedia.

Also: things never change...

The entire financial transaction, the largest in the United States history to date, was seen as contrary to two benchmark Republican/Jeffersonian principles: The goal of eliminating the national debt, and the fear of foreigners holding the bulk of that debt. There were also concerns about how to finance the purchase, which ultimately was accomplished by slashing naval expenditures even further.

[ilsm]

Aaron,

They should have borrowed the money fo rthe Mexican War.

Then Thoreau would never have gone to jail for refusing to paythe tax.

[ilsm]

Steve,

This view does not have the debt clock.

From memory I seem to recall that 40% of the debt is not publicly held.

That debt is cash interest free.

Such a good deal for the interest expense.

[gunthestops]

Actually the estimated interest on the total national debt of 8.7 trillion for FY2007 is about 450 billion, 250 billion in interest on the publicly held debt of 4.9 trillion. On the trust fund side of the debt 3.8 trillion is about 200 billion in interest, most of which is current SS surplus. But here is the cute part, the interest is not paid, the trust fund is given an IOU for 200 billion and then the taxpayer’s debt to the trust fund is increased by 200 billion.

In the authors post he subscribes to the alternate universe theory of debt and deficits. Running ever-larger debt and deficits is GOOD, passing on the largest debt ever to future generations is GOOD, lower taxes, higher incomes for the “me generation” is GOOD, fiscal responsibility BAD. Our current economy is built on a mountain of credit, I have no doubt it will come home to roost sooner or later, probably on our children and grandchildren.

[ilsm]

Ignorance or dishonesty:

Is that 'real income growth' for the median or the average?

[pawnking]

Gun, what is Fiscal Responsibility? By negative association, you seem to imply that it is:
Runner ever-smaller deficits, passing smaller debt onto the future generations, higher taxes, lower incomes.

Do I have your point correct?

[Syphax]

"Our current economy is built on a mountain of credit, I have no doubt it will come home to roost sooner or later, probably on our children and grandchildren"

If the anti-debt crowd really cared about our children and grandchildren they would do their research and find that the best way to help our children and grandchildren is with lower taxes.

There is a mountain of evidence that the less a country taxes as percentage of the economy the faster it grows. There are almost no exceptions to the rule, Ireland, Singapore and South Korea have very low taxes and have very very high growth. Countries like the United States, Canada, Australia and the UK have low taxes and good growth. Countries like Italy, France and Germany have high taxes and terrible growth. Obviously the US isn't in that bad of a situation, but we can certainly improve with lower taxes.

So the real question is what exactly is wrong about Steve's post? Higher growth means higher debt and interest payments can be sustained(not to mention higher incomes for all Americans and higher tax revenues without rate increases). Unless you believe that it would be impossible for the United States to grow faster than it currently is... you must agree with Steve here.

Finally I am confused about your constant complaining about the Social Security trust fund. Regardless of whether we are running surpluses 5% our GDP or deficits 5% our GDP Social Security is not sustainable as it is today(without faster growth, which you make no mention of). Even if Clinton's dream of paying the national debt off by 2010 was reality, it would NOT save social Security. 50 years from now $9 trillion dollars of debt will be as insignificant as $500 billion dollars was 50 years ago. In other words, paying down the national debt in 1956 would have had little impact on the national debt today just as paying down the national debt today will have little impact on the national debt in 2056.

If one really cares about their children and grandchildren they will...

a) forget about paying down the national debt to "save" social security, it might make us feel better, but it will do nothing to help our children and grandchildren.
b) Start talking about how to grow the economy... this can not only save social security, but also give our children and grand children more wealth and allow them to spend more on both social and defense programs
c) Start talking about reforming social security WITHOUT RAISING TAXES... as raising taxes will discourage work and encourage retirement(which is the exact opposite of what we want to do!)

[ilsm]

Syphax,

Not everyone would raise taxes.

I would cut spending and not just in the con artists' approach to cutting SS or entitlements.

So, how come you need debt, inflation and low interest rates to grow?

Taxes alone, up or down, do/did nothing to stimulate nor retard growth.

Cut spending, and pay back SS trust fund.

SS surplus has "permitted" the debt,and made cash available to see artificially low interest rates.

This done by overtaxing payrolls to allow under taxing income not related to working.

[Syphax]

"So, how come you need debt, inflation and low interest rates to grow?"

Debt isn't needed to grow, but certain things that are required for growth create debt. My question is does debt hold back growth? There is no evidence it does... Therefore no reason not to run small deficits.

"Taxes alone, up or down, do/did nothing to stimulate nor retard growth."

There is a tremendous amount of evidence that countries with low taxes perform better than those with high taxes. How can this be explained other than differences in tax rates?

"Cut spending, and pay back SS trust fund."

The argument that paying back the Social Security trust fund is severely flawed... The Social Security program has taken more in than it has been spending for 50 years(and will do so for 20-30 more years) but it will fall permanently into the red after that. Restoring the trust fund would save the program temporarily, but is not a permanent solution.

You still seem to ignore growth, which is the topic of the article. Do you believe faster growth is possible? If it is how? No one seems to bring this important part of the conversation up. That is Steve's point, and I for one think its a good one.

[ilsm]

"My question is does debt hold back growth? There is no evidence it does... Therefore no reason not to run small deficits."

In the period since debt monetarism became the rule, Reagan and beyond, with a break in the Clinton years, growth has been below post WW II average annuals.

Check with pgl at Angry Bear.

But you cannot look at debt without the externalities.

The fed has been very kind since Volcker defeated inflation, and they change the definition of inflation to keep the fed kind.

And the treasury has been kind, the fed also holds about a trillion bucks in the debt.

So, I would not argue debt is good unless you are leveraging some production enhancing stuff.

But a lot of the debt had covered federal waste, at best inefficient allocation, and consumption of mainly imports.

Not a thing borrowed by the federal government qualifies as productivity enhancing.

So, I do not see the reason for the debt to be leveraging.

Non governmental debt for productive things is absolutely growth enhancing.

Growth would be much better if the treasury did not borrow so much and the fed stopped running the presses.

Now you may be into monetarist money laundering and be well off better than if you worked and invested in real things.

That is not growth.

[Rich Berger]

ilsm

Why don't you return to Angry Bear where your views are better appreciated? It is difficult to understand what you are asserting, so mangled is your syntax - I feel like I am reading a twisted, inferior version of Alice in Wonderland.

[ilsm]

Rich Berger,

Noted