Fiscal position is unsustainable regardless of whether the Democrats or Republicans are in power
With the US election a week away, one thing that has been notably absent on the campaign trail has been talk of how either the Democrats or the Republicans will deal with the massive US government deficit if they win. One interpretation is that the candidates want to win over voters by focusing on what they will gain by their party being in power rather than what they would take away.
However, there’s no ignoring the size of the budget deficit and the potential impact it could have on financial markets. US government debt amounts to more than $35 trillion, now as large as the entire US economy and equivalent to about $105 000 a person.
Both the Democratic and Republican parties have contributed to the buildup of the debt burden to 125% of GDP. Trump oversaw an $8 trillion increase in the U.S. national debt. According to the Council of Foreign Relations, which argues that the US has a debt problem, Biden has continued the upward trajectory, with debt growing $1.7 trillion in the 2023 fiscal year.
Though views on the long-term sustainability of the US government debt mountain vary, we believe the US government deficit is set to become a significant problem and is not getting sufficient attention. At Flagship, we’ve done deep-dive work on how the US debt is evolving and why it will become a significant problem for the country. Unfortunately, the common outcome, regardless of who wins the elections, is continued fiscal deficits, resulting in an ever-increasing debt burden for the country.
On the surface, Democrats want to increase corporate tax rates (Republicans want them lower), create a Wealth Tax, and mess with the Estate Tax while cutting tax rates for the middle class.
Unfortunately, the US’s current expenditure is so out of sync with what it earns via taxes that changes in taxes alone will not change the trajectory of its deficit. As seen in the chart below, total revenue for the US in March 2024 was way short of meeting expenses. Total revenue for the month was $332bn. Expenses totalled $566bn. That’s a material difference, especially given that the US currently has a strong GDP and low unemployment. Working at the margin on tax receipts means very little regarding fiscal deficits when your main issue is spending. And there has been little from either candidate to address the level of the expenditure that would avoid further deficits.
Source: Flagship; US Congressional Budget Office
Historically, the federal deficit has fluctuated considerably, with notable spikes during major events like World War II, the 2008 financial crisis, and the COVID-19 pandemic. Before the pandemic, annual deficits typically ranged from 2-5% of GDP during normal economic times, though they rose substantially higher during crises.
The structural factors driving the deficit are largely bipartisan in nature. Both parties have contributed to deficit growth through different mechanisms - Republicans typically through tax cuts and defence spending increases, Democrats through expanded social programs and infrastructure investment.
The prevailing view is that some level of government deficit is manageable and even beneficial during economic downturns because the government can use public debt to support businesses and US households during recessions or crises, like the 2008 financial crisis and the Covid pandemic. However, US government debt has grown so significantly over the last few decades that there is little – if no - leeway left for putting together recovery packages that would tide the economy over in any crisis that materialises in future.
Ideally, the candidates should be looking to take advantage of the current economic boom to build up that buffer. However, neither election candidate has indicated any intention to embrace some level of fiscal austerity. In fact, the economic analysis shows the opposite, with Donald Trump’s proposed tax and spending plans projected to add $4.1 trillion to the debt over a decade and Kamala a lower—but still considerable—$2 trillion.
This year, investor attention has been focused on inflation and interest rates and US election polls in the build-up to the elections. While some argue that the deficit isn’t a problem because the economy is healthy and robust, and the stock market continues to rally, signalling there is nothing to worry about. However, the 2008 financial crisis is a keen reminder that financial excesses have a nasty habit of coming home to roost when you least expect it. By the time these unravel, it’s far more difficult – if not impossible - to make things right.