Should We Be Worried About How the Election Will Affect Public Finances?

The tension and uncertainty over the November 5 presidential election in the United States are at their peak. The polls have tightened, and the differences in voting intentions for Donald Trump and Kamala Harris fall well within each survey’s margin of error. Right now there’s no telling who will be sitting in the Oval Office on January 20.

Yet despite the uncertainty, we need to prepare for contingencies, and financial markets seem to be doing just that. The polls have shifted in Trump’s favour, leading some portfolio managers to make a few adjustments. Volatility on the US stock market is significantly higher than it was in the first half of the year, while bond market volatility has also jumped. In particular, bond yields have risen. Over the past month, the yield on US 10‑year bonds has climbed more than 60 basis points to almost 4.30%. Several factors have helped fuel the run-up in yields. First, the US economy is still going strong, as shown by some of this week’s major data releases. Third-quarter real GDP and the Conference Board Consumer Confidence Index posted solid gains. Even the underwhelming job numbers (mostly due to hurricanes and a labour dispute) don’t really change the overall picture. As a result, the Fed is likely in no rush to normalize interest rates. This means longer yields will feel less downward pressure.

But we shouldn’t underestimate the election’s impact on the outlook for financial markets, especially the bond market. As mentioned in our Economic Viewpoint External link. on election issues and the candidates’ platforms, the plans proposed by Kamala Harris and especially Donald Trump are inflationary in nature. More importantly, they could have major repercussions on US public finances.

This is especially true given that the federal government’s finances aren’t exactly stellar. This could be seen in the US Treasury’s official data for the 2024 fiscal year, which ended September 30. They showed a public deficit of US$1,832.8 billion. That’s worse than the US$1,695.2 billion deficit posted in fiscal 2023.

Why Have Federal Finances Deteriorated Once Again?

The biggest problem isn’t government revenues, which climbed US$479.5 billion, or 10.8%. The growth in household income and persistent inflation have boosted revenue from personal income tax by 11.5%, which accounts for half of that increase.

The problem is spending, which soared 10.1% (by US$617 billion) in fiscal 2024. Some of this increase is explained by the fact that we’re comparing against artificially low spending levels in 2023. These did not take into account the changes made to the student loan program in response to a Supreme Court decision. Once those changes are factored in, the increase falls to US$283 billion (+4.4%). Most of that increase is debt service payments totalling US$254 billion, mainly because of higher interest rates. We also noticed that spending went up on things like Social Security (+US$103 billion), defence (+US$50 billion) and Medicare (+US$28 billion). This was partly offset by a reduction in spending on the deposit insurance program (-US$55 billion), the pension guarantee program (-US$28 billion) and the food benefits program for low-income households (-US$28 billion).

Spiralling Debt

Of course, the size of the 2024 deficit drove up the national debt, which totalled US$35,464.7 billion as of September 30. On its own, debt held by the public (which excludes federal intergovernmental holdings but includes debt held by the Federal Reserve) amounted to US$28,307 billion. That’s equal to about 98% of GDP, up from 96% at the end of fiscal 2023.

The national debt will likely surpass GDP during the next few years. In its June projections, the Congressional Budget Office (CBO) slightly underestimated the size of the deficit and debt for 2024. It also sees debt held by the public growing to 99% in 2025 and 101.6% in 2026.

Neither of the two candidates’ proposed platforms are going to solve this problem. In our Economic Viewpoint External link., we estimated that the cost of Kamala Harris’s key measures could swell the deficit by almost US$2,695 billion over 10 years, even though some of the proposals would increase tax revenues. Donald Trump’s policy proposals would inflate the deficit even more, by US$4,900 billion. That doesn’t take into account the other proposed tax cuts he has put forward in recent weeks. It also doesn’t include any of his as-yet-unspecified plans to slash federal spending, including a commission on this subject that would presumably be led by Elon Musk.

There’s Still a Lot We Don’t Know

But it’s hard to believe the winner of Tuesday’s vote will have the power to do whatever they want when they take over the Oval Office in January. Economic and geopolitical conditions can quickly change a new administration’s priorities.

The presidential race is a toss-up, and we also don’t know which party will end up controlling the House and Senate. As of this writing, the odds suggest the Republicans will win a narrow majority in the Senate, while the Democrats take the House of Representatives by a razor-thin margin. This would be the exact opposite of the current configuration. A divided Congress always holds back the White House. In such a situation, if Harris were to win, the US would be in a similar situation to the one it’s in now, with very few new programs and no serious effort to balance the public books. And if Trump were to become president with a Democratic majority in the House, his new tax cuts would be dead on arrival.

It appears the markets are pricing in a potential Trump victory. However, they also seem to believe he’ll focus more on tax cuts than plans (such as imposing across-the-board tariffs and deporting immigrants) that most economists believe would hamper growth. This would be the best scenario for US corporate earnings. But a divided Congress would make it much less likely. If the Republicans don’t win a majority, Trump would have trouble passing new tax cuts for businesses and high-net-worth individuals. However, he would have more freedom to change trade and immigration policies. The US (and Canada External link.) may therefore have to deal with the consequences of more inflationary measures that would curb growth, without the potentially positive impact of additional tax cuts.

The long election campaign is almost over. But there are still a lot of uncertainties that could shake consumer confidence (as in 2016 and 2020, when confidence indexes shifted in response to partisan sentiment) and fuel market volatility, even after November 5. Unfortunately, there’s one thing we can bet on: short of a major turnaround and tremendous political courage, it doesn’t seem like US public finances will get any better.