Optimistic Budget Forecast Supported by Recent Data

The Federal Government announced that the 2025 budget deficit came in at $1.8 Trillion vs. a CBO estimate of $1.9 Trillion.  The lower than expected deficit was primarily driven by higher than forecast tariffs which came in at $195 billion.  We are now forecasting that the budget deficit for fiscal 2026 comes in at $1.45 trillion which is 4.6% of GDP vs. the CBO estimate of $1.7 trillion.  Our forecast assumes long term economic growth of 3%, which we believe is the current sustainable growth rate of the economy.  Our forecast is consistent with an IMF cross-sectional study of all nations that indicated that a country’s growth rate is correlated to its national savings rate with every 10% of national savings producing 1.5% of growth.  The current US national savings rate is approximately 20% implying a sustainable growth rate of 3.0%.  In addition, the 2017 reduction in the Federal corporate tax rate stimulated incremental investment which has increased the sustainable GDP growth rate.  Our 3% growth forecast is also supported by the Fed’s plan to reduce the Fed Funds rate to a neutral rate below 3%, which should cause the housing and construction sectors to emerge from recession.  The reduction in the deficit of $400 billion also boosts sustainable GDP growth by .2% as the reduction in the budget deficit frees up incremental capital for private investment driving higher GDP growth.   

Our forecast of a budget deficit of 4.6% of GDP is critical as the long-term expected growth rate of nominal GDP is 5% so any deficit level below 5% indicates that debt as a percent of GDP will gradually decline.  Our long -term forecast shows that the debt to GDP level falls to below 95% after 10 years from today’s level of 100.5%.  The critical driver is the increase in tariffs as the level of $400 billion is very significant with tariffs representing 80% of the amount of total corporate income taxes.  Many critics from both sides of the aisle have ignored the budget impact of tariffs, which has been the first major attempt to reduce the budget deficit since the Clinton administration.  Since tariffs can be imposed by the President it allows for a tax increase that would never be passed by congress as tax increases are extremely unpopular.  In an ideal world, of course, the budget would be balanced which would drive an incremental increase in the sustainable GDP growth rate of 1% to a sustainable rate of 4%.