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Your guide to what the 2024 US election means for Washington and the world
The writer is a managing director and economist at Pimco
As the US prepares for a new administration under Donald Trump, the long-term outlook for the national deficit and debt is coming into sharper focus.
At Pimco, we have already been making adjustments in response to the rising trajectory of US deficits. Specifically, we’ve been less inclined to lend to the US government at long maturities, favouring opportunities elsewhere. But the potential for some incremental improvements in near-term deficits relative to already dire expectations, could provide some modest relief to the bond market.
The Congressional Budget Office forecasts that the US debt-to-GDP ratio could exceed 200 per cent in the coming decades, primarily driven by demographic shifts. An ageing population will significantly increase healthcare costs, particularly for Medicare and Social Security, which are projected to be the main contributors to rising government spending. Both major political parties have historically avoided making substantial changes to these mandatory spending programmes, which limits the scope for meaningful budget reforms.
Trump’s campaign promised to reduce the current 6.5 per cent deficit to 3 per cent, while also extending the 2017 Tax Cuts and Jobs Act, implementing further tax cuts and achieving 3 per cent real GDP growth.
Achieving these goals simultaneously will be difficult if not impossible. Reaching a 3 per cent deficit would require identifying about $875bn in budget cuts, a task that would require bipartisan support in Congress. Such cuts could have serious implications for US growth, making a 3 per cent growth target difficult to reach.
According to the US National Income and Product Accounts, Federal government expenditures were about $1.8tn in fiscal year 2024. A reduction of $875bn would necessitate nearly a 9 per cent nominal growth in all other GDP expenditure categories to meet the administration’s 3 per cent growth targets. Historical data suggests that achieving such growth rates is unlikely, given that average nominal GDP growth rates have hovered about 3.5 per cent in the post-financial crisis era.
Politically, the challenge is even greater. The discretionary spending budget, excluding interest payments, was roughly $900bn in 2024. Cutting $875bn from discretionary spending alone would leave virtually no funding for essential services, including defence and education. Even significant reductions in spending areas mandated by legislation like Medicaid would likely fall short of the administrations goals.
However, a combination of rolling back parts of the Inflation Reduction Act, spending improvements, tariffs, and a temporary extension of tax cuts could mitigate further deficit expansion.
One feasible approach involves extending the TCJA provisions for a shorter duration. The estimated 10-year cost of extending the TCJA is about $4tn, but limiting the extension to four years could reduce that figure to about $1.8tn. Additionally, repealing some of the tax credits for investment in clean energy projects under the IRA could yield $100 to $400bn over the next decade’s savings.
Congress could also pursue reforms aimed at reducing fraud and waste in government spending. The Government Accountability Office has identified potential savings of between $400bn and $500bn annually through addressing inefficiencies in healthcare and defence. While implementing these reforms may require additional staffing and bipartisan co-operation, even modest efficiency gains of $100bn per year could lead to a $1tn reduction in deficits over a decade.
Another avenue for raising revenue will probably involve increasing tariffs on imports from China and other countries. Doubling current effective tariff rates could generate an estimated $400bn over 10 years.
For bond investors, this scenario is not entirely negative. The government’s efforts to finance tax cuts with a mix of economically feasible tariffs and government spending restraints could signal just enough recognition of fiscal constraints. This balance may also foster a favourable environment for equity markets, as more painful near-term fiscal adjustments are avoided.
In conclusion, while the US faces a daunting longer-term debt dilemma, the potential for incremental reforms and strategic fiscal measures could provide a near-term pathway to at least stabilise the deficit. While this isn’t a panacea, maybe it’s not a terrible outcome relative pretty downbeat US fiscal expectations.
Source: Economy - ft.com
