Investing.com – A second Trump administration is likely to see little change in the US fiscal deficit, despite campaign promises to cut taxes and spending programs, according to UBS strategists.
“Already high deficits will force compromise on tax cuts and spending pledges, and we believe corporate tax cuts are unlikely in the absence of much higher tariff income,” the Jason Draho-led team said in a note.
The US government deficit currently exceeds 7.5% of GDP, while the debt-to-GDP ratio has risen to more than 120%.
UBS notes that although a debt crisis is not imminent due to the US dollar's reserve currency status and deep capital markets, “the US government does not have unlimited borrowing capacity.”
To stabilize the debt-to-GDP ratio, strategists believe that measures such as entitlement reform, financial repression, or higher taxes will likely be needed.
The Republican-controlled Congress, although it retains the Senate, the House of Representatives and the presidency, is expected to face obstacles. The narrow majority in Congress and fiscal hawks within the party may challenge expansionary fiscal policies.
UBS stressed that the “high deficit” now represents a major constraint. For example, the incremental cost of Trump's proposed tax and spending policies is estimated at $7 trillion over ten years, potentially rising to $15 trillion in a more aggressive scenario.
“With today’s high budget deficits and narrow majorities, we believe Congress is likely to be reticent to approve measures that would further expand the deficit,” strategists note. “In fact, some members of the administration have talked about reducing the deficit-to-GDP ratio to 3%.”
Interest rates pose another challenge, as high interest rates have pushed government debt servicing costs beyond defense spending levels. UBS expects a modest decline in borrowing costs but notes risks from inflationary pressures, tariff policies and changes in Federal Reserve Treasury holdings.
The bank believes that Republicans are likely to pursue fiscal policies through reconciliation, a process that allows budget changes to be made with a simple majority in the Senate. This could include border security initiatives and attempts to extend provisions of the 2017 tax package.
However, extending the personal income tax cuts for a full decade would cost $4 trillion, a burden that UBS believes can be mitigated by limiting the extension to shorter periods. As UBS explains, setting the time horizon could reduce the cost to $1.3 trillion for a five-year extension.
“Shortening the time horizon for personal tax cuts could also help Republican leaders stay below the agreed-upon cumulative deficit target and help fund other policy pledges, such as corporate tax cuts, raising the state and local tax (SALT) deduction, and retaining the top tax.” “Property tax relief,” the strategists explain.
Efforts to offset financial measures are also constrained. Tariff revenues, although politically attractive, are unlikely to fill this gap. UBS points out that even imposing a 10% global tariff would generate just $2 trillion over ten years, and such a move would likely dampen domestic and global economic activity.
Likewise, spending cuts or efficiency gains would provide limited relief, with UBS describing such measures as akin to “looking for coins in the sofa cushions.”
As President-elect Trump begins his second term, UBS is highlighting growing concerns about America's financial health. With government debt exceeding 120% of GDP and interest costs consuming 13% of revenues – the highest among developed countries – the continuing high deficit is considered unsustainable.
UBS believes that although the immediate risks of a debt crisis are low, unchecked fiscal imbalances will constrain the government's ability to respond to future economic shocks. Achieving debt sustainability in the long term is likely to require a combination of high growth, low interest rates, and structural reforms, including financial repression, entitlement changes, and tax increases.
