Interest Costs Could Explode from High Rates and More Debt

Interest costs are projected to approach $1 trillion this year, nearly triple 2020 levels. In light of current interest rates and the ongoing reconciliation negotiations, they are likely to more than double by the end of the decade.

The 10-year Treasury yield rose to 4.5 percent this week, while the House Budget Committee advanced legislation that would add $3.3 trillion to the debt through Fiscal Year (FY) 2034 – or by $5.2 trillion if the bill is made permanent.

If the 10-year Treasury yield remains at 4.5 percent (and other yields maintain their projected spread) and lawmakers pass and ultimately extend the House reconciliation bill. We estimate:

• Net interest payments would total $15.7 trillion between FY 2025 and 2034, $2.7 trillion above baseline projections.
• Interest costs would more than double, from a projected $973 billion in 2025 to $2.2 trillion in 2034.
• Interest would reach a record 5.3 percent of Gross Domestic Product (GDP) by 2034 and consume 29 percent of all revenue.
• Interest would remain the second largest program – larger than Medicare or defense – and would approach the size of the Social Security retirement program by the end of the decade.

The Congressional Budget Office (CBO) projects interest payments will total $13 trillion through 2034. However, their projections assume 10-year Treasury yields of 4.1 percent this quarter, falling to 3.8 percent by 2034. CBO’s baseline also assumes, as under current law, large parts of the Tax Cuts and Jobs Act (TCJA) expire at the end of this year. Instead, the 10-year yield is at around 4.5 percent, and policymakers may be on course to not only extend but expand the cost of the TCJA.

Should 10-year Treasury yields remain around 4.5 percent – and other yields maintain the same spread from the 10-year as in CBO’s baseline – we estimate interest payments would be $1.8 trillion above baseline through 2034. If on top of that, lawmakers authorize $3.3 trillion in borrowing from the House reconciliation bill, interest payments could grow by an additional $680 billion – or $890 billion if various temporary tax cuts are extended and higher defense and homeland security spending are continued. In total, net interest payments would increase by $2.7 trillion, including nearly $540 billion in 2034 alone.

Already in 2024, spending on net interest surpassed all spending on Medicare and defense. With higher rates and debt, its costs would not only remain above those programs but come within 1.9 percent of the cost of Social Security’s retirement program, the most expensive line item in the budget.

As a share of the economy, net interest would grow from a record 3.2 percent of GDP in 2025 to 5.3 percent in 2034. And as a share of revenue, nearly 30 percent.

As we have shown before, when interest payments rise to service the debt, interest rates can also rise, slowing economic growth, further boosting federal debt, and setting up the US for a dangerous debt spiral where both interest rates and debt continue to rise. Given the recent unpredictability of the Treasury market, this risk is increased further. Volatility in the bond market could be a warning sign to get our current fiscal situation under control, as was the recent credit downgrade from Moody’s Ratings, another agency to strip the US of its perfect credit score citing “large annual fiscal deficits and growing interest costs.”

Lawmakers should find additional offsets to finance tax extensions and other costs. Our debt is on an unsustainable path which comes with many risks, a fiscal crisis among them, and these risks should not be elevated by adding on more debt and more interest. Thoughtful tax and spending reforms could instead work to keep interest rates and costs down and improve debt sustainability.