Andrew Harrer/Bloomberg

The U.S. Budget Is in the Perfect Sweet Spot, But That's About to Change

America's interest bill may triple by 2023
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Lawmakers in Washington may not even realize how lucky they are, at least when it comes to public finances.

An accelerating economy is pushing up tax revenue from individuals and corporations. Even better, rock-bottom interest rates are helping keep the cost of federal borrowing in check. Receipts for the first half of fiscal year 2015 increased 7 percent from a year ago, according to a Congressional Budget Office estimate released Wednesday. And for the full fiscal year, the deficit will probably be 2.7 percent of gross domestic product, compared with 2.8 percent the previous year and a whopping 9.8 percent in 2009. 

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Unfortunately, the U.S. can't have it both ways forever. While revenue from individual and corporate taxes are expected to keep growing until at least 2018,  most Federal Reserve officials want to raise their benchmark interest rate this year (although probably a little later in 2015 than previously thought, according to minutes of the March meeting released Wednesday). That will push up the cost of servicing the national debt in coming years. Eventually, net interest expenses will triple to $704 billion in 2023, exceeding the amount of money the U.S. will spend on defense that year, according to the  CBO.

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Some lawmakers are taking note.

"That is not a good business plan for our country," Senator Mark Warner, a Democrat from Virginia said, as he pointed to the raising interest costs during a Feb. 24 Senate Banking Committee hearing. According to Warner, a 1 percentage point increase in interest expense adds $120 billion a year to debt service. 

Fed officials, who kept the main rate near zero since 2008, estimate they will increase it to 0.625 percent by the end of this year and 1.875 percent in 2016. CBO  projects that between 2015 and 2025,  the average interest rate on 3-month Treasury bills will rise from 0.1 percent to 3.4 percent and the average rate on 10-year Treasury notes will rise from 2.6 percent to 4.6 percent. 

The problem is sort of self-perpetuating. Higher interest costs make the deficits larger, which requires the U.S. to borrow even more and  pay even more in interest. And the more the government has to spend on servicing debt, the less money it has for other purposes.  When lawmakers say the deficit isn't sustainable, that is what they mean.

The fact that the deficits have been decreasing as interest rates remained low kept Congress's appetite for budget and borrowing cuts in check. Once borrowing costs swell and cannibalize other government spending, lawmakers might feel pressed to do something about America's borrowing binge.

"This could very well be a 2017 story," said Stephen Stanley, chief economist at Amherst Pierpont Securities LLC in Stamford, Connecticut. "Because next year is going to be dominated by the presidential elections, I don't think you're going to have a lot of people running around arguing for austerity in the middle of the presidential campaign." 

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