Four Ways US Bond Markets Affect Tax Revenue

US government borrowing costs are in the news again. The benchmark 10-year Treasury interest rate (yield), which averaged 4.3 percent in the early part of 2026, averaged nearly 4.6 percent from June through mid-August. After the 10-year yield rose further in August, Treasury Secretary Scott Bessent intervened to push yields down.

Federal government debt is over $32 trillion, around the size of the nation’s annual economic output (its gross domestic product, or GDP). Debt levels this high mean US borrowing costs are sensitive to interest rate changes that may otherwise seem small. So, too, are federal taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. revenues.

Below are four ways Treasury interest rates directly and indirectly affect federal tax revenues.

Macroeconomic Effects

US government borrowing costs have a major impact on other borrowing costs in the economy. Mortgage, car, and business loan rates have moved in tandem with the 10-year Treasury yield for decades.

Rising Treasury rates, therefore, can affect the broader US economy by:

• Slowing consumption: Consumption is the largest part of the US economy, regularly accounting for more than two-thirds of GDP. When rising US Treasury yields push up the borrowing costs for purchasing a home or car, Americans either a) buy less of both or b) have less disposable income to purchase other goods and services.
• Slowing investment: Private investment makes up 18 percent of GDP, and businesses borrow a tremendous amount to finance new investments. Total US business debt approached $23 trillion in the first quarter of 2026. When rising Treasury yields push business borrowing costs higher, American companies either a) invest less or b) have fewer resources to devote to hiring, wages, and other needs.

Slowing consumption and investment, in turn, affect US tax revenues. Less consumption and investment can mean less property taxA property tax is primarily levied on immovable property like land and buildings, as well as on tangible personal property that is movable, like vehicles and equipment. Property taxes are the single largest source of state and local revenue in the U.S. and help fund schools, roads, police, and other services. revenue for municipalities, less sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding.  revenue for states, and less income tax revenue for states and the federal government. Lower borrowing costs—and higher consumption and investment—can produce the opposite effects.

Fiscal Effects

The government’s borrowing costs are quickly eating up a larger share of federal revenues. At the turn of the century, 11 cents of every tax dollar went to paying interest on the national debt. Today, it is 19 cents.

The extraordinary size of the debt means that even small moves in interest rates can have outsized effects on the nation’s fiscal future. According to the Congressional Budget Office, even a 0.1 percentage-point increase in the 10-year Treasury yield—sustained over a decade—would increase federal deficits by $379 billion.

Rising borrowing costs indirectly affect federal revenues by:

• Requiring more of every tax dollar to go to paying back the interest on our debt—under current projections, the share will rise to 37 cents for every dollar in the coming decades.
• Increasing the future gap between spending and revenues, meaning Congress will need to enact larger future spending cuts or tax increases to close the gap.

Revenues Coming In

While the negative economic and fiscal effects of rising borrowing costs will likely swamp any positive revenue effects, higher borrowing costs can lead to some increased tax revenue.

Unlike other types of investment income (such as long-term capital gains or qualified dividends), interest income is typically taxed at ordinary income tax rates. According to the Federal Reserve’s Survey of Consumer Finances, most US government bonds and bills are owned by the top 20 percent of income earners.

These earners typically pay higher marginal tax rates, meaning that the government recoups some of its higher borrowing costs through taxes on interest income. Of course, those taxes are only a fraction of the higher interest the government pays out.

When interest rates on business loans, mortgages, and other borrowing rise, private lenders also report higher interest income. Those lenders are taxed on that interest income—often at the 21 percent corporate tax rate—and pay more in taxes when interest income rises.

To the extent higher borrowing costs mean financial institutions also must pay higher yields to savers, net interest income (the difference between what financial institutions earn on loans and pay out to savers) may be lower.

Revenues Going Out

The flip side of higher interest income is higher interest deductibility. Borrowers can currently deduct several types of interest expense, summarized in Table 1 below:

Table 1. Federal Interest Deductions for Individuals and Businesses, 2026

Note: Revenue effects of the deduction = revenue lost (negative figures) or gained (positive figures) to the federal government for providing (or limiting) an interest deduction relative to the Joint Committee on Taxation’s (JCT) baseline income tax. JCT measures business interest deduction limits as revenue gained to the federal government because its baseline business tax system would tax all business interest income and fully allow business interest deductions.

Source: Scott Eastman and Anna Tyger, “The Home Mortgage Interest DeductionThe mortgage interest deduction is an itemized deduction for interest paid on home mortgages. It reduces households’ taxable incomes and, consequently, their total taxes paid. The Tax Cuts and Jobs Act (TCJA) reduced the amount of principal and limited the types of loans that qualify for the deduction.,” Tax Foundation, Oct. 15, 2019, https://taxfoundation.org/research/all/federal/home-mortgage-interest-deduction/; Andrew Lautz, “The Auto Loan Interest Deduction: How Claiming and Reporting Work,” Bipartisan Policy Center, Apr. 23, 2026, https://bipartisanpolicy.org/explainer/the-auto-loan-interest-deduction-how-claiming-and-reporting-work/; IRS, “Rev. Proc. 2025-32,” Oct. 9, 2025, https://bipartisanpolicy.org/explainer/the-auto-loan-interest-deduction-how-claiming-and-reporting-work/; IRS, “Questions and answers about the limitation on the deduction for business interest expense,” Aug. 19, 2026, https://www.irs.gov/newsroom/questions-and-answers-about-the-limitation-on-the-deduction-for-business-interest-expense; JCT, “Estimates of Federal Tax Expenditures for Fiscal Years 2025-2029,” Dec. 3, 2025, https://www.jct.gov/getattachment/8c830c45-1680-4f7e-a649-2a0106f6b6e3/x-45-25.pdf.

As Treasury yields push up borrowing costs throughout the economy, they may produce higher interest deductions and less taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. Taxable income differs from—and is less than—gross income.   for individuals and businesses.

Big Picture

With federal debt increasing from $3 trillion to $32 trillion since 2000, and annual budget deficits projected to average more than $2 trillion per year over the next decade, Treasury borrowing costs are more important to the economy and federal budget than ever.

Policymakers should not overlook the downstream effects of higher Treasury yields. As debt continues to climb, the feedback of higher borrowing costs for the US government will grow in tandem. Acting now to meaningfully reduce debt will involve fewer and less severe trade-offs for the economy and the federal budget than further delay.

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