Assessing the Economic Impact on Businesses Post-Election

Federal Budget Deficit vs. Debt: Where We Stand?

The lure of increased federal/national government spending to stimulate the economy or certain sectors is strong across the political spectrum, even though spending priorities, whether in defense, infrastructure, health care, education or social programs, may vary greatly. While high levels of government spending can have a stimulative effect, particularly in the short-term, it can also add to the government’s budget deficit. This is particularly problematic for countries that are still grappling with the heavy fiscal burden created by programs implemented in response to COVID-19.

Rising federal government debt is the elephant in the room as the U.S. debt burden is growing at an unsustainable pace. According to the latest analysis by the non-partisan Congressional Budget Office, interest expense on federal debt is expected to reach 3.4% of GDP in 2025, exceeding most other federal budget categories, including defense, Medicare and Medicaid mandatory spending. This analysis reflects current law, without taking into account the impact of further fiscal spending promised during the presidential campaign trail.¹

Recent analysis by the independent Penn Wharton Budget Model of the spending and tax plans of the presidential candidates shows that both plans would add significantly to the deficit over the next 10 years.² That equation is further complicated by uncertainty over the fate of the Tax Cuts and Jobs Act of 2017 (TCJA) as certain temporary tax cut provisions are set to expire in 2025. By some estimates, making those provisions permanent would add in excess of $4 trillion over the next 10 years to the national debt. On the other hand, not extending some of the provisions may weigh on consumer spending in the near to medium term, as disposable income would decline for some income echelons.

Promises that higher spending or tax cuts will stimulate the economy creating a fiscal multiplier effect that will offset the deficit impact are not borne out by research or the historical record. Politicians often believe that the increase in economic growth will create tax revenues that will far outweigh the extra fiscal spending, which is not what typically has happened. If investors doubt the credibility of such promises, it can lead to financial market turmoil. The UK experience in 2022 offers a cautionary tale. Shortly after taking office, the government of Prime Minister Liz Truss proposed a significant tax cut, including reductions in top income tax rates, claiming that lowering the top rates would more than pay for themselves by boosting economic growth. Financial markets, already reeling from the economic shock of the war in Ukraine, responded with a massive sell-off of UK government bonds that sent interest rates soaring and the British pound plunging in value. The Truss government quickly backtracked but the damage was done and contributed to her resignation shortly thereafter after just 49 days as Prime Minister—the shortest term in UK history. More recently, the International Monetary Fund (IMF) has been sounding the alarm on the dangers of large fiscal deficits and elevated debt levels, which have been on an upward trajectory across the globe, calling for fiscal prudence.³

For businesses, the impact of higher government debt burden is most directly felt in its impact on interest rates. In the U.S., expectations are that the U.S. Federal Reserve, which had raised interest rates to a 20-year high as it tried to rein in inflation, will make several interest rate cuts in the coming months. However, in the longer term, the unsustainability of a high government debt burden is likely to exert upward pressure on interest rates and debt yields. This can impact virtually all sectors of the economy by raising the cost of capital, pressuring valuations and balance sheets, inhibiting M&A and private equity activity, and leading to delayed or deferred capital investment.

The Ripple Effect of Regulatory Changes

Given a choice, businesses generally favor less regulation than more, but what they dislike most is uncertainty because it makes it difficult, if not impossible, to plan, manage, or make strategic decisions. An uncertain election outcome between candidates with widely divergent policies and approaches on regulation, coupled with the uncertain impact of recent court decisions—especially the Supreme Court’s recent overruling of the “Chevron” doctrine, which limits the ability of administrative agencies to interpret regulations—has created uncertainty around both current and future regulation, with potentially profound implications for business.

That uncertainty can already be seen playing out in the rapidly emerging AI sector. While concerns over return on the massive investments being made has already roiled equity markets in 2024, regulation remains another important wild card as regulators and elected officials in the U.S. and around the world weigh AI’s potential productivity gains and economic benefits against safety, privacy and bias concerns.

The political stakes in elections are often self-evident. The economic stakes for businesses and consumers, while less certain, can be just as high. The outcome of the U.S. elections may result in significant ramifications to the rest of the world.

Sources
1 “An Update to the Budget and Economic Outlook: 2024 to 2034”, Congressional Budget Office, June 2024.
2 Analysis as of August 26, 2024, which does not take into account any more recent proposals that may be introduced during the campaign period leading up to election day on November 5, 2024. For the latest analyses, visit: https://budgetmodel.wharton.upenn.edu/.
3 “Political Parties of all Stripes are Pushing for Higher Government Spending”, IMF Blog, September 16, 2024.