The Rising Cost of Government Debt
Over recent years the amount of U.S. government debt outstanding has received increased attention, and for good reason. When President Reagan was inaugurated in January 1981 he began his warnings about excessive debt and deficits at a time when federal debt outstanding was just under $1 trillion ($930 billion). At the end of the most recent fiscal year, Sept. 30, the level of federal debt outstanding had exploded to $37.638 trillion, a staggering sum of almost $110,000 for each person (including children) in the U.S.; in January 1981 that figure was about $4,100 per person.
What has become important in the exploding U.S. debt environment is not simply the size of that debt but the cost of interest the government needs to pay every year. The U.S. government rarely pays down the principal of their debt – the last time the U.S. government had an annual surplus and reduced the debt outstanding was in 2001. Since then, the government has run deficits for 24 consecutive years, with a record $3.13 trillion deficit in 2020, the year of the Covid-19 outbreak.
With the very low interest rate levels during the Global Financial Crisis (2007-09) through the Covid period (2021) the cost of servicing the Federal debt – known as Net Interest Expense – did not rise significantly. From $183.5 billion in 2005, Net Interest did not even double in the 16 years to 2021, rising to $352.3 billion. But in the following 4 years, the surge in the amount of debt outstanding, combined with rising interest rates, pushed Net Interest Expense to a record $970.6bn.
The surge in Interest Expense has become a burden on the flexibility of Federal budget policy, rising to the fourth largest category of the government budget in 2025, passing the spending on national defense ($912.5 billion) for the first time ever. A comparison of the composition of Federal government annual spending over the last 20 years shows how dominant categories over which there is little flexibility – categories called non-discretionary spending – have become.
Share of Federal government Expenditures (% of Total)
FY2005
Social Security 21.1
Defense 19.9
Medicare 12.1
Health Programs 10.1
Net Interest 7.4
FY2025
Social Security 22.5
Defense 13.0
Medicare 14.2
Health Programs 14.0
Net Interest 13.8
While discussions about the rise in government spending often focus on the rising cost of Social Security and Medicare, over the last 20 years those two categories of spending have increased by a combined 3.5 percentage points (pp) of total expenditures. Total spending on health programs has risen faster over those 20 years, increasing their share by 3.9 pp. But by far the largest increase in the share of Federal spending over the last 20 years is for Net Interest, with the burden of interest payments rising by 6.4 pp to a record 13.8% of total spending. Of the five largest categories of spending, only the share of National Defense has declined in the last two decades, with the decline of 6.9 pp almost completely offset by the 6.4 pp increase of Net Interest.
To make matters worse, while a dominant percentage of money spent on Social Security, Medicare and Health stays within the U.S. economy, the latest data shows that almost 25% of Treasury debt - $9.16 trillion – is held by foreign central banks and investors. That suggests that about $240 billion of net interest paid by the Treasury in the last year about was paid to foreign investors, draining that spending power out of the U.S. economy. The good news is that if interest rates continue to decline into 2026, Federal spending on servicing the existing debt could stabilize. The bad news is that Net Interest expense if unlikely to fall below 12% of total expenditures during the decade ahead, limiting the flexibility of Federal spending policies, particularly at a time when the aging U.S. population suggests rising spending on Social Security and Medicare will place an increasing burden on U.S. taxpayers.
