President Joe Biden is taking victory laps for last year’s reduced budget deficit. I would be happy to see this number drop in a significant manner. But the decline has nothing to do with the president’s policies, and it changes little about the dangers of our fiscal situation.
According to the Treasury Department’s monthly reports, the budget deficit for May was $66 Billion. The deficit for 2022 fiscal year stands at $426 billion. With four months left, this year’s deficit will indeed be significantly lower than last year’s, which was nearly $2.8 trillion. There’s nothing like $5 trillion in COVID-19-relief spending paid for with borrowed cash to balloon a deficit!
Biden’s administration did nothing to bring about the deficit’s decline. Credit must be given to the large increase in tax revenues as the economy rebounded and the decision of Democratic Sens. Kyrsten Sinema and Joe Manchin and their Republican colleagues to block Biden’s expensive “Build Back Better” proposal. Build Back Better would have made many of the emergency programs that were created or expanded during the pandemic permanent. If it had been passed, government spending would have risen and deficits would have been even higher.
That said, the still-too-close-to-$1 trillion deficit for FY 2022 is inexcusably large. Even more concerning is the cost that taxpayers must bear because of the COVID-19 deficits. The Treasury report also states that the U.S. government paid $56 Billion in interest payments in May on its debt, an increase of $44 Billion in April. The total interest payments for this fiscal year are now $311 billion. With four months remaining on this figure, we can expect a total interest expense for FY 2022 to be at least $500 billion.
This is only the beginning. The Congressional Budget Office predicted that interest payments on U.S. government debt would consume 8% and 40% of gross domestic product by 2050, before the pandemic and the inflation caused by irresponsible spending and easy money. These projections assumed that interest rates would rise slowly over a long time. However, as of today, the short-term figures look optimistic as inflation and the Federal Reserve’s response to it are boosting interest rates.
Higher interest rates today will increase interest payments shortly afterwards, since so much of our debt has a short term maturity. According to the Treasury, total interest rate on marketable debt in May was 1.733%, up from 1.66 in April, and increasing. This pace could see us reach 2% by the end the year. A calculation by the Mercatus Center’s Jack Salmon finds that a 1% increase in interest rates would result in annual interest payments of $1.06 trillion while a 2% increase would elevate these annual payments to $1.45 trillion.
It’s expensive for sure, but it is also a vicious cycle if the interest is paid for with yet more borrowing. Increased borrowing means higher interest payments. If one believes, as I do, that most of the current inflation is due to recent fiscal irresponsibility then borrowing more to pay more interest will only fuel the inflation fire.
Finally, as the average marketable interest rate approaches 2%, we are approaching the threshold that left-leaning economists suggest should cause concern about the size government debt.
In 2020, economists Jason Furman and Lawrence Summers weren’t worried about this. Historical low interest rates seemed to be set to continue. Still, out of academic rigor, they laid out some markers for when we might start worrying about the debt: “As a new guidepost, we propose that fiscal policy focus on supporting economic growth while preventing real debt service from being projected to rise quickly or to rise above 2% of GDP over the forthcoming decade.”
Today, the public has 98% of GDP as debt. At a 1.734% interest rate we currently spend 1.7% of GDP on interest. We should be worried if the Federal Reserve raises rates significantly higher than what is projected to manage inflation.
The budget deficit may be lower than it was at the peak of the pandemic, which is a good thing and predictable. But it’s no cause for celebration as interest rates and servicing costs could push us into worrisome territory sooner than we think.
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