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Obama budget plan shows interest payments on national debt quadrupling in next decade

By Steven Mufson
Washington Post Staff Writer
Thursday, February 17, 2011; A01

Interest payments on the national debt will quadruple in the next decade and every man, woman and child in the United States will be paying more than $2,500 a year to cover for the nation's past profligacy, according to figures in President Obama's new budget plan.

Starting in 2014, net interest payments will surpass the amount spent on education, transportation, energy and all other discretionary programs outside defense. In 2018, they will outstrip Medicare spending. Only the amounts spent on defense and Social Security would remain bigger under the president's plan.

The soaring bill for interest payments is one of the biggest obstacles to balancing the federal budget, pushing the White House and Congress to come up with cuts deeper than previously imagined. Unlike with discretionary spending or even entitlement programs, the line item for interest payments cannot be altered except through other budget cuts.

The phenomenon is a bit like running up the down escalator. Without interest payments, the president's plan would balance the budget by 2017. But net interest payments that year are expected to reach $627 billion, up from $207 billion in the current fiscal year.

"This goes to the heart of why we have to address our fiscal problems," said Mark Zandi, co-founder and chief economist at Moody's Economy.com. "If we don't, we're going to get swamped by our interest payments."

Benjamin Friedman, a Harvard economic professor and author of "Day of Reckoning," about U.S. economic policy, said, "I think it's a reminder that we have a very serious problem and that the budget that's on the table does not address that problem."

Even with the cuts in Obama's budget, relief would not come until 2021, when the deficit as a percentage of gross domestic product would stop rising and plateau at 3.4 percent.

The explosion of interest payments comes from a double whammy of economic factors. First, the nation's debt is growing faster than the economy. Second, interest rates are rising. Over the next decade, net interest payments will amount to nearly80 percent of the debt added, an indication of how past borrowing is forcing the country deeper into debt.

"We're running a gigantic deficit, and we're not growing very fast," said Kenneth Rogoff, an economics professor at Harvard University and former chief economist at the International Monetary Fund. "We're on a dramatically unsustainable path."

The Obama administration's latest forecasts starkly illustrate the phenomenon of generation shifting, moving today's costs to future taxpayers. The borrowing the United States did over the past decade - to pay for the 2001 tax cut, the wars in Iraq and Afghanistan, and propping up the economy during the steep 2009 downturn - is coming due this decade.

As bad as the outlook is in the Obama budget proposal for fiscal 2012, it could get worse. So far, interest payments have been relatively low because of the willingness of global investors to lend the U.S. government money at abnormally low interest rates. But that could change.

"The scary scenario - which I am not predicting but is a real possibility - is an incident of capital flight, where investors lose confidence in the U.S., causing interest rates to rise precipitously and pushing the budget deficit even further into the red," said N. Gregory Mankiw, a Harvard economics professor and former chairman of President George W. Bush's Council of Economic Advisers.

The Obama budget's assumptions include a substantial increase in rates. It predicts that the interest rate on 10-year Treasury notes will climb from 3 percent this year to 3.6 percent next year. It forecasts rates of 5 percent by 2015 and 5.3 percent at the end of the decade.

Short-term rates will rise even more sharply, from nearly zero now to 4 percent by 2015 in the Office of Management and Budget assumptions.

Rogoff calls the administration's forecast "reasonable," but he warns that the actual number is hard to know with any certainty.

"The basic issue is that when you hold a lot of debt you're vulnerable to shifts in sentiment and sharp rises in the interest rates," Rogoff said.

He said that combined federal, state and municipal debt in the United States is at a record high, beyond the famous post-World War II levels. Unlike interest payments made then, however, a huge portion of interest payments are flowing to investors in other countries, draining funds out of the U.S. economy. (There are other interest payments made to the Social Security fund, but because they shift money from one pocket of the government to another, they are not counted in the net interest numbers.)

Some positive developments could ease the interest payment crisis, including faster-than-expected economic recovery, higher-than-expected tax receipts and lower-than-expected government borrowing rates.

Ultimately, Rogoff said, the federal government should aim to reduce the amount of debt as a percentage of GDP. But for now, the U.S. government is still borrowing just to meet the interest payments on earlier borrowing.

"We are in a self-reinforcing, vicious cycle," Zandi said.

He compared the United States to European nations such as Greece or Portugal, or developing nations that in the past have received bailouts from the European Central Bank or the IMF.

"But there's no one we can get help from," Zandi said, noting that no economy is bigger than the U.S. economy. "There's no sugar daddy out there for us."

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