The US Fed is increasing its interest rate targets. These rates will eventually affect most other interest rates in the US economy. In particular, interest rates on US government bonds will also increase, which should increase the US government debt servicing costs. Moreover, the government has over 10 trillion dollars in debt, so, the effect on its costs could even force it to increase tax rates. So, is the interest rate increase by the Fed eventually going to lead to an increase in federal tax rates? Thanks!
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$\begingroup$ It has been a bit since looking into it, but I think the fiscal theory of the price level argues that a government can cover such new debt issuance with seignorage (inflating the debt away) so that it is not necessary to raise taxes. I am leaving this as a comment and not an answer because I am not positive that this is entirely correct. Anyway - may be worth doing a bit of reading. $\endgroup$– 123Commented May 25, 2016 at 2:25
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$\begingroup$ I think this is correct. Alas, inflating debt, means inflating the future debt service also... $\endgroup$– wiwuloCommented May 25, 2016 at 9:34
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2 Answers
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You have to differenciate the debt that is already existing from the one that is going to be issued: whenever the US Treasury issue a bond lets say a 10% coupon 10yrs... for a 100USD. It's still going to pay 10USD to the holders during the 10yrs. When you see the yield going up or down it's usually on the secondary market. I say usually because sometimes the government issues bond with a floating rate which can be impacted by a rate increase.
As for the new debt that is going to be issued you are right to say that this going to be more costly !
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$\begingroup$ yes, thank you. I am interested in the long-term consequences (10years+) $\endgroup$– wiwuloCommented May 25, 2016 at 9:38
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- For the Congressional Budget Office (01/2016), the answer is Yes:
"Because of rising interest rates and growing federal debt held by the public, the government’s interest payments on that debt are projected to rise sharply over the next 10 years—more than tripling in nominal terms and more than doubling as a percentage of GDP, from 1.4 percent to 3.0 percent." - Will that make the debt unsustainable?
As projected revenue is growing slower than debt, "Rising interest costs would force reductions in government programs".
So, there could be either reductions, either change changes in tax laws.
But the economic growth could also be stronger than projected.