Interest Costs Would Explode with $5.5 Trillion Reconciliation Package

A recent press report indicated that House leadership may be considering a budget resolution that would allow up to $5.5 trillion of net primary deficit increases through the reconciliation process. If enacted, this would increase additional borrowing by about 30 percent over the next decade, to a record 133 percent of Gross Domestic Product (GDP) by 2035 – nearly doubling the debt growth expected under current law.

This higher debt would also further explode interest payments. Already, interest costs have exceeded spending on Medicare and defense and are on track to reach and exceed record levels as a share of the economy. We estimate that passing an additional $5.5 trillion of new and extended tax cuts and spending without offsets would:

• Boost interest costs by about $1.3 trillion over the next decade, exceeding $250 billion per year by 2035.
• Increase annual federal net interest payments to $2.0 trillion or 4.7 percent of GDP by 2035, far above the previous record of 3.2 percent.
• Boost the interest-to-revenue ratio from 9 percent back in 2021 and 18 percent today to 27 percent by 2035 (compared to 22 percent under current law).
• Increase the risk of a debt spiral by pushing up long-term interest rates (R) and potentially slowing the long-term growth rate (G).

Some have argued that this $5.5 trillion proposal is actually far less costly – either by measuring it relative to a “current policy baseline” or claiming fantastical levels of economic growth. Yet as we’ve shown before, switching baselines would be a dangerous and reckless gambit that ignores, but does not change, the fact that unpaid-for tax extensions increase debt and substantially worsen the fiscal outlook. And while thoughtful tax cuts can strengthen the economy, the effects are likely to be modest and offset in part or whole by the negative economic effects of higher borrowing. Independent estimates have found that extending the expiring provisions of the Tax Cuts and Jobs Act (TCJA) could pay for -2 to 14 percent of themselves, producing $600 billion of dynamic feedback on the high end and losing an extra $60 billion on the low end. No estimate is even close to the $3 trillion the House is apparently considering claiming.

Additional Borrowing Would Add $1.3 Trillion of Interest Payments

If lawmakers pass a bill that increases deficits by $5.5 trillion, we estimate that will lead to approximately $1.3 trillion in additional interest payments over the next decade, including the debt service on the additional borrowing and the added cost from the higher interest rates creditors will charge for holding extra debt.¹ By 2035, we estimate such a package would increase interest costs by more than $250 billion per year.

Interest payments which are already high and rising, would exceed $2.0 trillion per year by the end of the decade, compared with less than $1.8 trillion under current law.

Interest Payments Would Reach New Heights

As interest costs rise, they could become dangerously large as a share of the economy. Since 1962, interest costs have averaged 2 percent of GDP and 11 percent of revenue. Before this year, they never exceeded 3.2 percent of GDP or 19 percent of all federal revenue.

Under this $5.5 trillion proposal, we estimate interest costs would grow from currently 3.1 percent of GDP to 4.7 percent by 2035, a 50 percent increase. Over a third of that increase would be directly attributable to this proposal.

As a share of revenue, we estimate that interest costs will grow from comprising 18 percent of all revenues today to 27 percent of revenues in 2035. This level of interest payments as a percent of revenue – and as a percent of output – would put the United States in uncharted fiscal territory.

We Could Face a Debt Spiral

A higher national debt means more interest payments – both because more debt is serviced, and because higher debt pushes up interest rates and slows economic growth. These higher interest payments and slower growth can then further boost debt, leading to further interest costs. When this cycle pushes average interest rates above the growth rate (R>G), the country enters a debt spiral – where the national debt can spin out of control even without further primary deficits. $5.5 trillion of borrowing could push the federal government into a debt spiral sooner than expected, perhaps beginning within the next decade.

The Congressional Budget Office (CBO) estimates that for every one percentage point increase in the government’s debt-to-GDP ratio, interest rates will increase by 2 basis points (0.02 percentage points); some experts think the effect is over twice as large.

Based on CBO’s dynamic estimates of extending the individual income tax provisions of the TCJA, we estimate the average interest rate on all debt will grow to 3.7 percent by 2035, within 0.1% of CBO’s expected GDP growth rate.² The interest rate (R) may very well exceed the growth rate (G) by 2035, given that long-term yields are currently about 30 basis points above CBO projections, and markets expect them to continue to exceed CBO projections. Beyond 2035, average rates would continue to rise as debt rolled over and yields continued to increase, which could ultimately cause the debt to spiral out of control.

With interest rates already near their 17-year high, the national debt is on an increasingly unsustainable path. Adding $5.5 trillion plus interest to the national debt will make things far worse, putting the federal budget at greater risk of a debt spiral and perhaps even an eventual fiscal crisis.

For all these reasons and more, lawmakers should focus on finding ways to limit the fiscal impact of any tax extensions and at minimum fully pay for any tax cuts so that the budget reconciliation process can be used for its intended purpose, deficit reduction.

1 We assume the $5.5 trillion of borrowing will include the extension of the expiring TCJA individual tax provisions, plus more generous tax treatment of business investments, additional individual tax cuts, and $300 billion in extra spending at the start of the budget window, balanced by $300 billion in steadily growing spending cuts. This would lead to over $1 trillion of debt service, before dynamic effects. Using CBO’s projections of the interest rate effect of allowing the TCJA to expire, we estimate over $250 billion of interest costs from higher rates.

2 A $5.5 trillion package that includes TCJA extension is very likely to boost GDP over the decade and somewhat likely to boost GDP in 2035, but it is more likely to reduce than increase the rate of GDP growth by 2035. As one data point, CBO finds extending TCJA’s individual provisions will boost output by 1.08 percent between 2026 and 2034, reduce output by 0.08 percent in 2034, and reduce the GDP growth rate by 0.06 percent in 2034. As a second data point, the Penn Wharton Budget Model indicates that reverting various TCJA business provisions to their 2021 structures would boost GDP by an average of 0.23 percent through 2035 and boost GDP by 0.16 percent in 2035, but slow the growth rate of GDP by about 0.01 percent in 2032