How President Trump’s plans will impact the US deficit

To begin with, the US fiscal position is not in a good place. Even after the Covid-related spike in borrowing during 2020-22, the US government continues to spend far more than it takes in through tax revenue. The Federal deficit is running at 6.7% of GDP, while net government debt [1], which was 35% of GDP 20 years ago, looks set to breach 100% of GDP this fiscal year.[2]

Concerns about the fiscal trajectory are growing, with the US having now lost its Triple A rating with S&P, Fitch and, just last month, Moody’s. On top of this, President Trump’s One Big Beautiful Bill Act will extend and expand his huge tax cuts from 2017. The Congressional Budget Office estimates this will lower tax revenues by $3.7tr over the next 10 years, while proposed spending cuts would only save $1.3tr, leaving the primary deficit[3] $2.4tr wider than would otherwise have been the case.

On the face of it, this is a huge fiscal giveaway, but we need to remember that most of the Bill is merely an extension of the 2017 tax cuts, which had been due to sunset at the end of this year. So, while it provides lots of red ink for the long-term fiscal metrics, it generates no positive impetus for US economic activity relative to trends already in place.

The good news for the fiscal hawks out there is that President Trump’s tariffs are already generating tax revenues that are separate from the OBBBA. On top of this, we have some “efficiency savings” being generated by DOGE, but those are admittedly modest at less than $200bn.

While these initiatives may fill the financial hole created by OBBBA, US deficits will remain wide and debt levels will continue to grow, especially when we consider the continuous 0.1-0.2pp GDP increase in demography-related spending and how that will feed into the US’s fiscal position. Moreover, the combination of these policies is likely to be detrimental to economic growth in the near term, which runs the risk of official deficit and debt projections being too optimistic.

That’s because OBBBA is, on balance, likely to be a headwind for growth with additional tax cuts over and above the extension of the 2017 Tax Cuts and Jobs Act being offset by the spending cuts that are falling heavily on “green” investment support and healthcare.

As for tariffs, in addition to raising revenue, they are intended to encourage the reshoring of manufacturing to the US which boosts growth longer term, secures intellectual property and strengthens the resilience of supply chains. However, the near-term result will be some combination of higher prices for consumers that eat into household spending power and weaker corporate profits as firms absorb some of the cost. Hiring and investment are already slowing, and there are also warning signals that investment growth is stalling in an environment of heightened economic and geopolitical uncertainty.

We expect US growth to slow from 2.5% in 2024 to average at 1.5% in 2025-26, which is 0.3-0.4pps weaker than what is assumed in the official fiscal projections. Combining this with our more cautious view on the interest rate trajectory, we believe the US fiscal performance should be skewed to the negative side of the Congressional Budget Office’s (CBO) forecast range. We expect the deficit to stay at or more than 6% of GDP for much of the coming decade, with debt-to-GDP ratios continuing to rise by around 2pps or more per year.

[1] In this article we focus on the US net debt, which refers to total (gross) debt excluding holdings by US government entities. For reference, as of the 2024 fiscal year, net public debt was 96.4% of GDP vs. gross debt of 121% of GDP.

[2] Discussing the budget parameters, in this article we refer to US fiscal years (eg, FY24: 1 October 2023 – 30 September 2024).

[3] Deficit before debt interest expenses

The current budget performance underscores the persistent structural challenges in reducing the federal deficit, with pressures evident on both the expenditure and revenue sides. However, persistently high and rising expenditures remain the primary driver of the widening gap.

• Discretionary spending, which the US administration directly controls, stands at 6.0% of GDP, its lowest level in 50 years. Notably, defence spending, the largest component, is also at historic lows. Given ongoing geopolitical tensions, further reductions in this area appear highly unlikely.
• Mandatory spending, currently at 14.7% of GDP and governed by congressional statutes, is approaching historic highs. The primary drivers – Social Security and healthcare programmes such as Medicare and Medicaid – continue to face upward pressure due to ongoing demographic shifts.
• The end of the ultra-low-interest rate era, combined with a growing debt stock, has significantly increased the burden of net interest payments. These have risen from 1.5-2.0% of GDP (a range maintained from the early 2000s through 2022) to 3.2% of GDP, surpassing the mid-1990s peak. With nearly half of the deficit now attributable to interest expenses, the federal budget has become highly sensitive to interest rate dynamics.

On the revenue side, the post-pandemic recovery has plateaued, with federal revenues stabilising at around 17% of GDP, broadly in line with historic norms.

Major revenue sources – individual income taxes, payroll taxes, and corporate taxes – are at or slightly above their long-term averages. Minor revenue categories remain somewhat below average.

Customs duties, historically negligible at 0.2-0.3% of GDP, have gained prominence due to the current administration’s tariff initiatives. In May 2025, customs revenues surged 324% year-over-year, resulting in a 44% increase in the 12-month rolling total. This has raised their contribution to 0.4% of GDP – still modest, but a notable increase from a low base.

The current fiscal performance is on the pessimistic side of what the Congressional Budget Office (CBO) in early 2025 projected for the next decade: fiscal deficits in the 5-7% of GDP range. These forecasts predated the introduction of several new policy initiatives, including:

• Tariff increases,
• The One Big Beautiful Bill Act (OBBBA),
• Cost-saving measures by DOGE.

Based on the CBO’s analysis of the foreign trade tariffs introduced between January and May and of the OBBBA, the combined effect of the two initiatives, if implemented as is, appears to offset each other for the baseline projections. Taken separately, they tilt the long-term cumulative fiscal deficit rather moderately at 0.7% of GDP in each direction.

The tariff hikes are expected to reduce the cumulative 11-year deficit by $2.8tr (12%), as increased customs revenues and lower debt servicing costs are projected to offset the negative impact on GDP growth.

Conversely, the OBBBA, which extends the 2017 tax cuts, is projected to increase the deficit by a similar amount. The anticipated revenue shortfall is expected to outweigh any cost savings, leading to higher debt servicing costs.

One Big Beautiful Bill Act

Looking at the headlines alone, this Bill appears to be a huge fiscal giveaway, but in fact the bulk of the “tax cuts” are merely an extension of Trump’s 2017 Tax Cuts and Jobs Act (TCJA), with an estimated fiscal effect of $3.9tr over 2025-34. Without this bill, millions of households would face higher tax bills in 2026 as tax rates and deductions return to previous levels. Consequently, this means that cementing in these tax changes needs to be acknowledged within the fiscal projections, leading to larger future deficits.

In short, OBBBA will merely avoid a material deterioration in domestic demand, while doing nothing to boost the current growth trend. Outside of the TCJA extension, the provisions of the OBBBA should reduce the 10-year primary deficit by $1.5tr through reduced deductions and lower funding for healthcare and other sectors.

As for DOGE, even its self-reported savings of $180bn are relatively minor in the broader fiscal context. While initial targets of $1-2tr appeared substantial, the lack of clarity around the timeframe diminishes their perceived impact. Assuming those savings are expected to accumulate over a 10-11-year horizon, and that the target is reached, this sum would represent only about one-third of the expected fiscal benefit from the tariff increases discussed above.

The fiscal initiatives by the Trump administration might not be perfect and are subject to a few challenges, but the potential cost of doing nothing would be even higher. The CBO’s recent analysis of various fiscal scenarios suggests that should revenues and non-interest expenditures be allowed to return to their 30-year averages, the primary deficit and interest expenses would balloon, leading to the US public debt ending up more than $10tr (25% if GDP) higher than the baseline by the end of 2035.

Alternatively, implementing austerity measures is essential to completely halt the increase in public debt. In a hypothetical scenario of debt remaining at current levels, not only does revenue collection need to rise by almost 1 percentage point of GDP above historical averages, but spending also needs to fall 3 percentage points of GDP below its long-run average.

We take the two alternatives as extreme cases, while the actual fiscal framework should lie somewhere in between.

While fiscal policy decisions play a central role in shaping the US budget outlook, the fiscal trajectory is also highly sensitive to external macroeconomic conditions. For example, the CBO highlights several exogenous variables – such as interest rates, productivity growth, and a squeezing out of private investments – that can change long-term deficit outcomes just as much as major policy shifts.

The key notable sensitivities we can take away from these scenarios are:

• Each 0.1pp increase in interest rates translates into an additional 0.1% of GDP in annual interest costs for the US budget. If interest rates remain near current levels throughout the forecast period, we estimate an additional $1tr in cumulative interest costs between 2025-35 – equivalent to 0.6% of GDP above the CBO baseline (which assumes a decline in the rates). Here, we see risks skewed to the upside. Ongoing loose fiscal policy, as signalled by large primary deficits, will potentially need to be offset by tighter monetary policy to keep inflation in line with the 2% target. If the neutral Fed funds rate is closer to 3.25-3.5%, as we think, building a yield curve on top of that would suggest that the 10Y may average around 4-4.2% rather than the 3.8% assumed by the CBO.
• Each 0.1pp deviation in total factor productivity (TFP) growth from the baseline alters the annual primary deficit by approximately 0.1% of GDP. If, contrary to the CBO baseline, structural constraints on labour and capital persist – resulting in long-term GDP growth of just 1.0-1.5% instead of the baseline 1.5-2.0% – the cumulative primary deficit for 2025-35 could be 0.5pps of GDP higher than the baseline. Rapid adoption of new technologies and reshoring of high-value-added, highly automated manufacturing should, in theory, keep productivity growth elevated.
• Each $1 of new federal deficit historically reduces private investment by $0.33, and this sensitivity is embedded into the baseline fiscal scenario. If this sensitivity were to double to $0.66 per dollar of deficit – say, due to further domestication of the US Treasuries market, which is a risk but not our base case – the resulting drag on GDP and upward pressure on interest rates could increase the cumulative 11-year deficit by 0.6% of GDP compared to the baseline over the forecast period.

We’re at a key juncture when it comes to US debt dynamics. Government debt is approximately equal to the value of GDP. This makes the mathematics relatively easy, as debt dynamics are broadly determined by whether the growth in nominal GDP is above or below the average coupon print on the debt. Provided the former is higher than the latter, then the debt/GDP ratio can trend lower. Or it would, had it not been for the fact that the US runs a primary fiscal deficit (the deficit when interest payments are excluded).

In the US, the primary deficit ran at around 4% of GDP in 2024 and is projected at around 3% of GDP in 2025. If we assume a 3% primary deficit, for the debt/GDP ratio to fall, then the value of GDP must grow by more than the average coupon print plus 3%. The weighted average fixed coupon print right now is around 2.85%. Bills then tend to account for around 20% of total debt and are rolling over at a cost of around 4.25%. That comes to an average interest rate cost of a little over 3%.

The average coupon print plus the primary deficit is around 6%. So the value of nominal GDP needs to rise by some 6% for the debt/GDP ratio to stabilise. A repeat of 2024’s c.4.5% value increase risks adding 1.5% to the debt/GDP ratio on an annual basis. Something similar over subsequent years would continue to build the debt/GDP ratio. And, as the debt/GDP ratio rises above 100%, the problem is amplified.

Given we see some upside risk to the CBO’s assumption that interest rates move lower from current levels, we expect the debt-to-GDP ratio to rise by between 1.5pp and 2pp of GDP per year.