The Fiscal State of the Union

by | February 26, 2024

On March 7, President Biden will deliver his State of the Union address. We summarized some of the key economic aspects in an earlier piece, and now turn our focus to US fiscal policy.

One of the few ‘known knowns’ about US politics is that whoever is sworn in as US President on January 20, 2025, and which ever parties have assumed majority control of the US Senate and House of Representatives, will be confronted by two gargantuan fiscal policy challenges.

Large structural budget deficit

First, the new Congress and president will face a federal government budget deficit of roughly $1.5 trillion dollars, or approximately 5.3% of US GDP. While US budget deficits have been larger (both in absolute size and as a percentage of GDP) in the past, the current shortfall coincides with what economists generally consider a fully employed economy. 

That is unusual and typically unwelcome. Even the most fervent Keynesians, who support the use of fiscal policy to offset cyclical swings in growth, unemployment, and inflation, believe that tax and spending policies should roughly balance over the business cycle. Put differently, expansionary fiscal policies ought to be antidotes to recessions, but in periods of full employment the gap between tax revenues and government expenditures should narrow, even move into surplus. 

To be sure, some allowance for deficits is appropriate for government investment that primarily benefits future generations. For example, it was perfectly plausible to argue that Eisenhower’s initiatives to build an interstate highway system should be debt financed, with some of the cost absorbed by future generations benefitting from modern highways. In the same sense, today’s investments in de-carbonizing US energy usage, expanding rural internet access, and national defense ought to be debt financed, as the largest beneficiaries may not yet be born.

Nevertheless, it remains the case that the US government today is running a large structural budget deficit of nearly 5% of GDP, and that merits attention. According to the non-partisan Congressional Budget Office (CBO), for example, approximately 85% of the current federal budget deficit, or about $1.3 trillion, is structural, not cyclical. The biggest chunk of the budget deficit, in other words, will not go away as the economy continues to grow.

Expiring tax provisions

The second huge challenge that will confront the next Congress and president is that in 2026 significant provisions of the 2017 Tax Cuts and Jobs Act (TCJA) will expire. Those were the series of tax cuts passed during the Trump Administration that, among other things, slashed corporate and personal income tax rates, and altered other important parts of the US federal tax code regarding deductions and other taxable items. 

Should the TCJA ‘sunset’ at the end of 2025 without changes most US households will face higher effective tax rates due to the return to higher marginal rates of taxation and a smaller standard deduction. The ceiling on exemption from inheritance taxes will also roughly halve. In contrast, most of the changes to corporate taxation (apart from ‘bonus depreciation’) were made permanent by the TCJA and will not expire.

Few things are likely to focus minds in Washington, DC next year more than the political fallout that will ensue if Congress and the president fail to address the expiration of TCJA tax provisions.

In an ideal world, the expiration of the TCJA presents an opportunity for policymakers to simultaneously tackle the structural budget deficit and tax reform. In practice, however, that would seem to require degrees of bi-partisan agreement that in recent years have eluded American politics. 

Moreover, during this year’s runup to the general election it is unlikely that any politician will honestly discuss what deficit reduction or tax reform implies. It is left to us, therefore, to ask (and offer answers to) the fundamental questions about US fiscal policy that our elected officials will confront next year.

The questions politicians will avoid in 2024

First, are today’s federal government deficits the by-product of excessive spending or insufficient taxation?

As of 2023, US federal net outlays amounted to 22.4% of US GDP. That is above their postwar (1950-2023) average of 19.5% of GDP. It is also higher than their ‘Great Society’ (e.g., after 1965 and including mandatory Medicare and Medicaid programs) average of 20.2% of GDP. 

On the tax side, last year US federal tax receipts amounted to 16.2% of GDP, below the post-1950 average of 16.9% and below their ‘Great Society’ average of 17.0%.

Based on those figures, today’s US budget deficit appears to be more of a ‘spending’ rather than ‘tax’ problem and is comprised of roughly 2.5% of GDP of excess spending and roughly 1% of GDP in tax revenue deficiency.

If, however, the basis of comparison is shifted to those years defined by the CBO when the US had a zero or positive structural federal government budget balance, the arithmetic looks somewhat different. In those years (1998-2001), tax revenues as a share of GDP were 19.1%, while the expenditure share was 17.7%.

Viewed this way, government spending today remains too high. But tax revenues are also too low. The implication is that restoring the structural federal deficit to balance will require roughly equal contributions from spending cuts and tax increases. 

Which brings us to our second question: What is the trajectory for federal government spending?

The common perception is that government spending is steadily rising, but that is only correct in nominal (i.e., dollar terms). As a share of GDP, US federal government spending has been essentially flat since 1980, averaging roughly21% of US GDP. It has jumped, of course, during economic and financial crises, but has generally declined during expansions.

During the pandemic, for example, federal government spending as a share of GDP increased to a postwar record high of 31%. Since then, owing to a combination of a robust economic recovery and the expiration of various pandemic-related fiscal measures, the ratio has dropped by eight percentage points to its current level of 22.4%. 

What about trends in federal government tax receipts? 

Broadly, federal government taxation, as a share of GDP, has been stable in the US since the mid-1960s. It was, however, on average about 1.5% of GDP higher in the two decades from 1981-2001 than it has been over the past 20 years.

Which brings us to our final question: Can the US structural budget deficit be closed primarily via expenditure reduction?

The answer depends on various factors, above all what is politically feasible. But it is also important to understand what would be required if spending, alone, was the primary lever to restore structural fiscal balance.

Federal spending can be divided into two categories: mandatory and discretionary programs. Mandatory spending does not require annual Congressional authorizing legislation, signed by the president. Rather, it is spending that automatically occurs for eligible recipients. 

The largest mandatory programs are, in order of size (and as a share of the total budget), Social Security (23%), Medicare (14%), Medicaid and related healthcare spending (12%), and other mandatory programs such as veterans benefits (14%). In other words, 63% of all federal spending is not subject to annual appropriations legislation. The figure rises to over 70% if net interest payments on the US debt are included as ‘mandatory’.

Of the roughly 30% of federal spending that does require authorization (i.e., ‘discretionary’ spending) or represents interest on the national debt, the split is nearly equal between non-defense (16%) and defense (14%) programs. 

Returning to our question about whether a structural budget deficit can be restored to balance primarily via expenditure cuts, the answer is probably not if only discretionary spending items are considered.

Why not? Because out of total discretionary spending in 2023 of $1.7 trillion dollars, roughly $800 billion (or 47% of the total) would have to be slashed to achieve a reduction of total federal government spending equivalent to 3% of GDP (i.e., restoring net government spending to its postwar average level relative to GDP). In practice, that would mean cutting in half the Pentagon budget as well as half of all current spending on education, transportation, research and development, and government salaries. That strikes us as politically implausible.

The alternative is to revisit mandatory spending, most probably by changing eligibility requirements, and raising retirement or Medicare qualification ages. Those discussions are apt to arise in any event, given shifting US demographics. But history suggests that the largest mandatory programs (Social Security and Medicare) are highly popular, and political resistance to benefit cuts would be substantial.


In short, both arithmetic and politics make it clear that fiscal adjustment in the US will require contributions from both spending restraint and increased tax revenues. While a new Congress and president may not want to face the implied difficult and unpopular choices, next year they will be confronted by the expiration of provisions in the tax code that probably cannot be left unaddressed. Given that reality, structural fiscal adjustment and tax reform should be tackled simultaneously. We expect, however, that will be politically very difficult.

The inescapable conclusion is that 2025 will be a year of fiscal reckoning.

Filed Under: Economics . Featured . Politics

About the Author

Larry Hatheway has over 25 years’ experience as an economist and multi-asset investment professional. He is co-founder, with Alexander Friedman, of Jackson Hole Economics, a non-profit offering commentary and analysis on the global economy, matters of public policy, and capital markets. Larry is also the founder of HarborAdvisors, LLC, an investment advisory firm catering to family offices and institutional clients worldwide.

Previously, Larry worked at GAM Investments from 2015-2019 as Group Chief Economist and Global Head of Investment Solutions, where he was responsible for a team of 50 investment professionals managing over $10bn in assets. While at GAM, Larry authored numerous articles on the world economy, policy-making, and multi-asset investment strategy.

From 1992 until 2015 Larry worked at UBS Investment Bank as Chief Economist (2005-2015), Head of Global Asset Allocation (2001-2012), Global Head of Fixed Income and Currency Strategy (1998-2001), Chief Economist, Asia (1995-1998) and Senior International Economist (1992-1995). Larry is widely recognized for his appearances on Bloomberg TV, CNBC, the BBC, CNN, and other media outlets. He frequently publishes articles and opinion pieces for Bloomberg, Barron’s, and Project Syndicate, among others.

Larry holds a PhD in Economics from the University of Texas, an MA in International Studies from the Johns Hopkins University, and a BA in History and German from Whitman College. Larry is married with four grown children and resides with his wife in Redding, CT, alongside their dog, chickens, bees, and a few ‘loaner’ sheep and goats.

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