Investing.com – Trump's second administration may see little change in the US fiscal deficit, despite campaign promises of tax cuts and spending programs, according to UBS strategists.
“The already high deficit will force tax cuts and spending commitments, and we think corporate tax cuts are unlikely due to the lack of very high tax revenues,” the group led by Jason Draho said in a note.
The US government deficit currently exceeds 7.5% of GDP, while the debt-to-GDP ratio has risen to over 120%.
UBS notes that while a debt crisis has not yet occurred due to the financial condition of the US dollar and deep capital markets, “the US government does not have unlimited borrowing power.”
To stabilize the debt-to-GDP ratio, strategists believe that measures such as policy reforms, monetary tightening, or higher taxes will be needed.
The Republican-controlled Congress, despite holding the Senate, House, and President, is expected to face obstacles. Many of the major congressional and fiscal hawks in the party may challenge the expansionary monetary policies.
UBS stressed that the “high deficit” is now a significant constraint. For example, the additional costs of Trump's proposed tax and spending policies are estimated at $7 trillion over 10 years, which could rise to $15 trillion in a more aggressive scenario.
“With today's high budget shortfall and tight surplus, we think Congress may not be interested in implementing measures that will further increase the deficit,” the expert noted. In fact, some members of the administration have talked about lowering the deficit-to-GDP ratio to 3%.
Interest rates are another challenge, as high rates have pushed the government's debt service costs beyond defense spending levels. UBS expects a modest decline in borrowing costs but notes risks from inflationary pressures, tax policies, and changes in the Federal Reserve's Treasury holdings.
Banks believes Republicans can pursue fiscal policies through reconciliation, a process that allows for budget reform and a simple Senate majority. This could include border security measures and efforts to increase benefits from the 2017 tax package.
However, extending the personal income tax cut for a full decade would cost $4 trillion, a burden UBS believes could be reduced by reducing the short-term extension. As UBS explains, reducing the time horizon can reduce costs to 1.3 trillion dollars for a five-year extension.
“Expanding the tax cuts could help Republican leaders stay below the agreed-upon deficit figure and help fund other policy commitments, such as corporate tax cuts, State and Local Tax deductions (SALT), and maintaining top taxes. exemption from real estate tax,” experts explain.
Efforts to measure currency rates have also been hampered. Tax revenue, while politically attractive, is unlikely to fill the void. UBS notes that imposing a 10% general tax rate would only generate $2 trillion over 10 years, and that such a move would depress local and global economic activity.
Similarly, spending cuts or austerity measures will provide limited relief, with UBS describing such measures as “looking for coins in sofa cushions.”
As President-elect Trump begins his second term, UBS highlights growing concerns about America's financial health. With public debt exceeding 120% of GDP and interest costs consuming 13% of revenues – the highest among developed nations – the continuation of the increase in deficits is considered unending.
UBS believes that although the immediate risks of a credit crisis are low, unchecked financial imbalances will strain the government's ability to respond to future economic shocks. Achieving long-term debt sustainability will require a mix of high growth, low prices, and structural reforms, including monetary tightening, policy changes, and tax increases.