Timothy T. Taylor Home Page
Journal of Economic Perspectives
Articles and Writing
Economics Textbook
Classroom Teaching
The Teaching Company
High School Pedagogy

Articles and Writing

February 4, 1992
"You Owe $800 in Federal Interest"
San Jose Mercury News

By Timothy Taylor
<< Back to 1992 menu

AS THE federal government makes $199 billion in interest payments in 1992, your share, along with every other man, woman and child in the United States, is about $800. The borrowed money didn't seem to buy better education or national infrastructure or industrial competitiveness, or anything that is still with the nation today. The feeling is more like paying off credit cards for trips already taken.

Interest payments exploded in the late 1970s and early 1980s. Over the quarter century from 1951 to 1975, they had always fallen in a narrow band, between 1.2 and 1.5 percent of gross national product. Since the gross national product in 1992 should be about $5.8 trillion, that level of interest payments would have been $70 billion to $87 billion.

But from 1979 to 1985, interest payments exploded at a rate of 13 percent per year faster than the rate of inflation. At the end of that burst, interest payments were 3.3 percent of GNP, more than double their usual historical level, and they have stayed at that level since. In other words, current interest payments are about $120 billion per year above the level of the '50s, '60s and '70s.

Two main factors spurred the runaway interest payments. In the late 1970s and early 1980s, the federal government had to pay more for its borrowing. The interest paid on three-month Treasury bills rose from 7 percent in 1978 to 14 percent in 1981, before sinking back to the 7 percent range by 1985.

Then as interest rates fell, huge budget deficits were piling up, keeping the total cost of borrowing high. From 1983 to 1986, the deficit averaged $206 billion.

Currently, about $2.7 trillion in federal debt is held by investors outside the federal government. (Another $900 billion is held by other agencies of the federal government, but since this is a matter of the government owing money to itself, it isn't counted as part of the government drain on private sector savings.)

Who receives this $199 billion in federal interest payments? As the table shows, it's a varied group. Foreign investors hold about 18 percent of the debt directly; if they receive a proportionate share of the interest payments, that would be about $40 billion. Clearly, it isn't quite right to conclude that the federal government has been financing its borrowing directly from Japan and Germany and other foreign investors.

While U.S. individuals hold only 11 percent of the debt directly, they hold much more through their banks, insurance companies, money market funds, pensions, and so on. So how can you tell whether your household is a gainer from federal interest payments?

Consider a statistically average family of four. Total interest payments for this family are $3,200 per year. To receive that much interest from the federal government (at the 6 percent rates currently being paid), the family would have to own more than $50,000 in federal debt, whether directly or indirectly.

Since only the wealthy have tens of thousands of dollars invested in anything, the moral is clear: Federal interest payments are a $199 billion payment that generally flows from the average taxpayer to the rich.

Reducing interest payments isn't easy. Four options are available, two fast and foolish, two slower and sensible.

One option might be called the Latin American solution: default on the loans. A second method is to generate high inflation to reduce the costs of paying debt. If inflation rose to 10 percent, for example, it would shrink the economic value of $2.7 trillion in debt by $270 billion in a single year.

The world's biggest borrower, the U.S. government, has a financial incentive to create high inflation, but this cure for high interest payments is obviously worse than the disease.

The sensible ways to cut interest payments are to reduce interest rates and the amount borrowed. Reducing the deficit by much isn't slated for this year or next. However, the recent decline in interest rates will help reduce interest costs on this year's borrowing. The immediate savings are not huge, because the government must still pay last year's interest rates on last year's debt, but in four years, a sustained one- point drop in interest rates will be saving about $30 billion per year in interest payments.

Whether your fancies run to a lower deficit, or a tax cut, or spending more on health or education or something else, it would help if interest payments were at their historical levels, about $120 billion less. But the hard lesson for those who borrow too much, whether the medium is credit cards or junk bonds or the national debt, is that it's too late to repent after the money has been spent.

Wednesday: Elderly Support

As of September 1990, these were the investors who held the $2.2 trillion outstanding in federal debt.

Foreign $405 billion
State, local governments $344 billion
Individuals $238 billion
Commercial banks $188 billion
Insurance companies $139 billion
Corporations $99 billion
Money market funds $33 billion
Other $760 billion

Source: 1991 Economic Report of the President, Table B-86. The category of "other" includes savings and loans, credit unions, pension trust funds, dealers and brokers, and still others.

<< Back to 1992 menu