Worry Less About the Deficit

You’re saving a mint by refinancing. So is the federal government.

The Office of Management and Budget this week boosted its Fiscal 2003 budget deficit prediction to $455 billion. (I’m still betting that by year’s end we’ll reach Moneybox’s pessimistic April prediction of a $500 billion deficit. Any takers?)

As expected, OMB head Josh Bolten pooh-poohed the red flood as “manageable.” After all, the annual deficit only accounts for 4.2 percent of the Gross National Product—a smaller percentage than in the early 1980s and early 1990s. Bolten is more right than critics want to admit. Even though our national debt is growing rapidly, at $6.72 trillion and counting, the near-term situation isn’t particularly dire. The need to pay interest and principal won’t render the government unable to pay for necessities like defense and social programs. That’s because the government is taking advantage of the same refinancing boom that you are.

When you take out a mortgage, it’s not necessarily the amount you borrow that matters. Rather, the interest rate dictates how easily you can handle the loan. It costs about the same to repay the interest and principal of a $700,000 loan at 8 percent over 30 years as it does to pay back an $850,000 loan at 6 percent over the same time period.

The same holds for the national debt, although on a much bigger scale. The national debt has exploded over the years. But since the late 1990s, interest payments as a percentage of federal outlays have declined rapidly. In fiscal 1997, the first year of surplus, interest on the public debt consumed $355 billion, or 22.1 percent of federal outlays. Last year, interest costs fell to $332 billion (roughly the 1995 total), amounting to only 16.5 percent of total layouts. (This chart shows interest expense on a monthly basis for the past year and for every year since 1990.)

Indeed, it turns out that taxpayers have been among the largest beneficiaries of the downdraft in interest rates. The Treasury Department constantly refinances its existing debt, replacing old or expired bonds and bills with new bills and notes. And like home owners, it has been able to do so at progressively lower interest rates.

These figures show that on June 30, 2003, the average interest on our debt was 4.73 percent—down from 5.55 percent the year before. The difference of 81 basis points on a debt of $6.6 trillion saves $53.5 billion dollars in annual interest costs. And when the government goes to issue new debt today, it does so at rock-bottom rates. Treasury borrows for three months at an annual rate of .895 percent. In May, it issued a 10-year note at a remarkably low 3.625 percent.

The virtuous circle isn’t done yet. Some 30-year bonds can be paid off after 25 years. So in November, for example, Treasury can pay off some $5.23 billion in bonds issued in 1978. They bear an onerous rate of 8.75 percent. It can replace them with 10-year bonds at about half that rate.

In a sense, the return to deficits has come at a fortuitous time. It makes sense to load up on debt when interest rates are low. That’s what smart companies do. Of course, the bias toward short-term borrowing means the Treasury has to roll over debt more frequently, so if rates rise, interest payments could quickly rocket up. And we will—eventually—have to repay the principal that’s being added to the debt. The latest projection suggests $1.9 trillion will be added to the total national debt in the next five years.

The problem with the exploding deficit isn’t that we can’t afford to service the debt or repay the principal during the next few years. The problem is the Bush administration’s faith in a phony solution. The Republicans’ conventional wisdom is that once the economy starts growing rapidly again, it will generate the sort of ‘90s tax revenue gusher that will rebalance the budget by the end of this decade. Tomorrow I’ll explain why that hopeful theory is wrong.