In the latest round of budget talks we have found out every item is on the table except one: interest. Oddly enough, no one is talking about it.
Interest costs should be the most visible part of any budget discussion for three reasons. Firstly, interest expense — a projected $420 billion for the fiscal year of 2013 — is a large component of our budget. Secondly, these costs have explosive upside potential. Finally, interest expense is completely uncontrollable.
No other cost of government can escalate so quickly without voter approval. Entitlements will increase rapidly over time, provided that voters do not act. Voters can, however, change that growth. For example, the White House even proposed cuts to Social Security this year. If we go to war foolishly, the troops can be brought home. Voters have the power to change and shape the priority of Congressional authorizations.
This electoral oversight does not exist for interest expense because cost is set by the market not the voter. Today, the U.S. government has roughly $17 trillion of debt. We will pay roughly $420 billion to support that debt. If the effective interest rates rises to 5%, a reasonable rate based on historic data, interest would more than double to $850 billion. That would mean that the government would have find $430 billion in spending cuts.
That level of cost cutting is staggering. By comparison, the sequester has forced cuts of $85 billion in 2013. Some writers describe the cuts as severe while others counter that these reductions are not cuts, but rather a slowing in the growth of spending. Whichever side you choose, you at least can take a side.
But that is not the case with interest where the price is set by the market.
The cost of interest is referred to as the interest burden which measures how much of your taxes go to support debt. The U.S. government expects pay about $420 billion in interest in 2013. Given that the government's estimated revenue in 2013 is about $1.7 trillion, roughly 25 cents of every dollar goes to pay for past consumption. If your 1040 said that you owed $6,000, roughly $1,500 of that amount was interest.
Our interest burden does not pay down our debt. It is the cost simply to support the cost of past consumption. The level of debt is set by voters past. The cost of the debt is set by the market. The consequence is felt by voters today — 25% of what you contribute to the government is spent on things that previous voters wanted enough to have, but do not enough to pay for.
Politicians will play games with the numbers that determine interest burden. They will want to add roughly a $1.0 trillion of payroll taxes to revenue. The problem is that the government collects payroll taxes in exchange for the promise of future benefits. When the government gets cash today in exchange for cash back tomorrow, it is not a tax. It is a loan.
It is not entirely honest to add payroll taxes to revenue because that money is already committed to past promises. This revenue is not available to cover interest. Actually, the case can be made that payroll taxes are in fact interest and principal payments on payroll "loans" from the past. The payment of benefits is in many aspects just interest on the payroll taxes that were collected in the past.
Politicians will argue that much of the interest is "owed to ourselves." They want to ignore this cost — roughly 200 billion in 2013 — because the interest is due to various trust funds. The problem is that this interest isn't owed to ourselves. It is owed to future beneficiaries, for whom the government is acting as a fiduciary. Suggesting that interest is owed to ourselves is a serious breach of fiduciary responsibility.
For as long as I have been alive, Washington's politicians have pretended to worry about future generations. And that pretense is alive and well today. The problem is that we are the future generations that past politicians pretended to worry about. Today, politicians are largely pretending that we aren't.