Summary
In this note we examine the US fiscal trajectory and explore Treasury auction data over the last decade. Key takeaways include the unsustainability of the current fiscal trajectory, the difficulty of achieving a 3% deficit target, Treasury continuing to target short maturities and the importance of foreign investor demand as support for US Treasury auctions.
US Government Revenue & Spending Composition
The US Government collected $4.9tn in taxes in 2024. Income and payroll taxes accounted for $4.1tn, corporate taxes $0.5tn and tariffs $0.077tn. The Administration has created the ERS1 to compliment the IRS and levy taxes on foreigners. Tariffs currently account for less than 1.5% of revenues.
The US Government collected $4.9tn in taxes in 2024. Income and payroll taxes accounted for $4.1tn, corporate taxes $0.5tn and tariffs $0.077tn. The Administration has created the ERS to compliment the IRS and levy taxes on foreigners. Tariffs currently account for less than 1.5% of revenues.
Spending in FY2024 was $6.8tn and falls into three broad categories: (i) mandatory spending of $4.1tn, including Medicare and Health, Social Security and Veterans; (ii) discretionary spending of $1.8tn, including defense at $0.9tn and non-defense spending of 1tn; and (iii) interest payments which account for $0.9tn of spending.
The balance is the deficit, which stood at $1.8tn in FY2024 or roughly 7% of GDP. A level of spending unseen since large crises or wartime.
Treasury Secretary Bessent’s 3 / 3 / 3 Rule
The Treasury Secretary has proposed a set of 3 measures to put the US economy on a solid footing. The 3 / 3 / 3 rule targets a 3% deficit, 3% GDP growth and a rise of 3m barrels per day in domestic oil production. What will it take to cut the deficit from the prevailing 7% to 3%? Unfortunately, the path is a difficult one.
Economic Growth – Bank of America estimates 10% nominal GDP growth could cut the deficit to 3% but this assumes spending and revenue are static. The Trump Administration is proposing an additional $4.5tn in tax cuts, likely in one big spending bill to be passed later this year. One pillar of the tax cut argument is that it is an efficient form of fiscal stimulus, more money for individuals and corporates stimulates growth through multiplier effects. Spending generates income for counterparties in economic transactions with a portion re-spent in the economy. The Administration made this argument in 2016 as one justification for the first round of tax cuts and believes it worked until COVID hit the economy.
Spending Cuts – Mandatory spending is politically hard to cut as it hits health, retirement, education and veterans. At $4.1tn or 60% of total spending in FY2024 it is a large line item. Defense spending at $0.9tn has bi-partisan support and is expected to increase in the coming years. Interest costs are subject to macroeconomic forces. The Administration is looking at ways to lower longer term yields through favorable regulatory changes2, spending cuts and keeping issuance to short maturities. The average maturity of Treasury debt is roughly 6 years with a significant amount of debt maturing in the next few years that will roll into higher yields. Bank of America estimates that the 5 year note would have to rally over 100bp to keep current interest cost static.
Realistically, cuts to mandatory spending will have to come from eliminating fraud or leveraging the Government’s quasi monopoly position to extract better pricing from its service providers, an area of focus for the DOGE3 which is updating the US Government’s outdated technology stack. The DOGE will also target discretionary spending. For defense, fraud detection and competitive pricing could generate savings and the remaining $1tn in non-defense is open to large cuts.
We recently received more clarity on the composition of the Administration’s large spending bill which has already passed in the House. The bill goes to the Senate next, then to reconciliation. It appears that President Trump had to compromise to pass the extension of the 2017 tax cuts with an agreement to cut spending as offsets. Extending the tax cuts will add roughly $4.5tn over ten years4 to the deficit. Proposed spending offsets appear to target lower income cohorts thru cuts to health care including Medicaid and cuts to education including food vouchers. Lower income cohorts have a higher marginal propensity to spend. The deficit is expected to rise under the proposed spending bill but could exclude many of the promises made during the campaign for more aggressive tax cuts. There is a risk the spending bill will result in a net fiscal tightening for the US economy.
Revenue Increases – Tariffs collected on imports contributed 1.5% to revenues in FY2024, or roughly $77bn. The new Administration wants deeper tax cuts while reducing the deficit. The United States levies lower tariffs than many of its trade partners, roughly on the order of 2-3%. If tariffs rise to 30%5 for all trading partners, assuming no retaliation, no FX devaluation and foreign manufacturers absorb price increases the US could raise $1tn6 from the effort.
Cutting the deficit to 3% is roughly $1.1tn using fiscal 2024 levels. A combination of DOGE cuts to deal with fraud, waste and improve Government procurement, a spending bill with aggressive cost cutting, in addition to large tariff increases could cover $1.1tn. It is still early days but so far this seems like a herculean task. DOGE claims headline cuts7 of $105bn and when prompted, Grok3, XAi’s latest SOTA LLM8 identifies only $8.8bn of savings to date. Increasing tariffs to 30%9 will be a global experiment in rectifying trade imbalances and a test of its revenue generating potential. At $77bn collected a year, tariff increases need to be large. This also involves a Faustian bargain with markets as a credible tariff strategy, even a fraction of the proposed tariff strategy10 will be an unambiguous negative for markets in the short term. In the long term, if manufacturing reshores to the United States under aggressive tariff policies we could see significant economic growth. Finally, let’s not forget the Administration is proposing another $4.5tn in tax cuts over ten years but with significant spending cuts as offsets. Without offsets, the tax cuts would expand the deficit by 5% of GDP but now it appears the proposed spending bill could be contractionary. A negative for risk assets.
Treasury Auctions
With many fiscal outcomes unsustainable, the US Government still needs to fund itself. Treasury auctions, the composition of US debt, the debt ceiling, the composition of debt buyers and projected fiscal largess are critical signpost and events for investors.
The new Treasury Secretary confirmed to markets there are no plans to change the composition of issuance in the near future. The Treasury will continue to issue a larger percentage of bills at the short end of the yield curve to fund itself and avoid longer term issuance (coupons) for the foreseeable future. Bill issuance is expected to rise overtime as existing, lower yielding debt matures and needs to be rolled over at higher rates. Rates need to rally significantly from here just to keep interest expense constant and offset the higher cost of funding for maturing paper. Increasing coupon issuance is negative for bonds and nullifies the Administration’s stated objective of lowering long term rates, in part to manage the ballooning deficit. One data point to watch is the Treasury’s Quarterly Refunding Announcement11 where the Treasury projects the composition and size of upcoming issuance.
Foreign participation is an important source of demand for US issuance. Indirect bidders are a proxy of foreign demand for US issuance, and we see there is significant participation, including longer maturities as large pools of foreign capital including Central Banks, pensions and insurers have large demand for safe, liquid assets to match longer dated liabilities.
Investor Takeaways
- The US fiscal trajectory is unsustainable
- Cutting the deficit to 3% is a herculean task
- Mandatory spending is politically difficult to cut where viable cuts require identification of massive fraud, waste or significant improvements in efficiency
Discretionary non-defense spending will face deep cuts
- Increased defense spending has bi-partisan support, outside of DOGE finding irregularities or improving Government procurement cuts are unlikely
- The Administration’s proposed spending bill extends the 2017 tax cuts but includes large spending cuts as offsets and appears contractionary
- Tariffs on imported goods generated $77bn in FY2024 or $1.5% of revenue
- To become a viable revenue source, tariffs need to rise significantly on all trading-partners while assuming no retaliation, no FX devaluation and foreign manufacturers absorbing price increases
- Treasury auctions, the composition of US debt, the debt ceiling, the composition of debt buyers and projected fiscal largess are critical signpost and events for investors
- Treasury will continue to issue a larger percentage of bills at the short end of the yield curve to fund itself and avoid longer term issuance (coupons) for the foreseeable future
- Foreign participation is an important source of demand for US issuance
Conclusion
There is no dignity quite so impressive, and no independence quite so important, as living within your means – Calvin Coolidge, 30th President of the United States.
The new Administration has recruited a talented group of individuals, is attempting to implement significant change and restructure many relationships both strategic and economic which had prevailed for a long period of time. It will be an interesting experiment and test the boundaries of many conventional ideas and prevailing wisdom. That being said, many of the stated objectives, particularly on the fiscal side create a difficult mix of tradeoffs with an unclear path to success.
Scenario 1: DOGE is ineffective, the Administration backs off from tariffs, proposed spending cuts are smaller, tax cuts are deeper, including promises made during the campaign. This policy mix is expansionary, and the deficit explodes above 10%. Yields will rise rapidly leading to a tightening of economic conditions and the risk of a buyers strike in US bonds, including large foreign buyers. This scenario forces eventual austerity measures, either on this Administration, a future one or more likely through a corrective process in markets.
Scenario 2: DOGE is effective, tariffs are effective, the spending bill extends tax cuts but also includes deep spending cuts to bring the deficit under control. On balance, this is a negative economic shock to the US economy. The deficit improves materially but removal of fiscal stimulus weakens growth conditions and weighs on risk assets including equities. Bonds perform strongly and the USD weakens. Lower yields improve the deficit trajectory, and a lower USD helps the Administration’s goal of re-shoring production to the United States.
Scenario 2 appears more likely at this time, primarily thru a fiscal tightening triggered by the spending bill. The impact of tariffs and DOGE will be more limited. The implication is risk assets will struggle in the coming months and investors should consider protective asset classes. The set of information informing macro is dynamic with priors updating continuously. The Administration’s approach has increased uncertainty and heightened volatility leading to a rich opportunity set for active investors.
1 External Revenue Service.
2 Reducing the Statutory Liquidity Ratio for Globally Systemic Important Banks (GSIBs).
3 Department of Government Efficiency.
4 https://www.cbpp.org/research/federal-budget/house-republican-budgets-45-trillion-tax-cut-doubles-down-on-costly.
5 Baseline proposal for reciprocal tariffs.
6 Source: Bank of America.
7 www.doge.gov
8 State-of-the-art Large Language Model
9 It remains unclear whether the Administration is committed to aggressive tariffs
10 Key dates include March 4th (Mexico, Canada tariffs), March 12th (Aluminum, Steel tariffs) and April 2nd (reciprocal tariffs on all trading partners adjusted for degree of protectionism based on several factors)
11 QRA
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