A significant increase in the deficit, can the U.S. debt handle this Republican tax cut proposal?

The U.S. tax reform bill is expected to increase the deficit by at least $4 trillion over the next decade, potentially laying a "big bomb" in the bond market.

As global trade tensions ease, domestic fiscal issues in the U.S. are quietly brewing greater risks. According to the latest research report from Barclays, the House version of the tax reform bill is projected to add approximately $4 trillion to the U.S. deficit over the next decade.

Currently, the U.S. deficit is at 6.5-7% of GDP, and this bill will further push up long-term U.S. Treasury yields, delivering a heavy blow to bond investors.

With tariff issues temporarily settled, investors are turning their attention to the tax reform bill progressing in Congress and its potential impact on the long-term U.S. deficit.

Deficit is destined to continue rising, bill will add $4 trillion to the deficit over the next decade

According to Barclays' analysis, one of the long-term issues with U.S. fiscal policy is that Congress employs "tricks" to make deficit forecasts appear smaller, such as front-loading tax cuts while back-loading spending cuts.

The current tax reform bill continues this trend. According to media reports, on Tuesday, the House Ways and Means Committee marked up the House version of the bill, which extends the soon-to-expire Tax Cuts and Jobs Act (TCJA), thereby adding nearly $3.8 trillion to the deficit over the next decade (beyond current law); it also adds $320 billion to the deficit through increased defense and immigration enforcement spending.

The bill recoups $1 trillion in taxes through various measures, such as eliminating electric vehicle tax credits, IRA credits, and payments under the Affordable Care Act. However, it subsequently adds $1 trillion to the deficit through new tax cuts requested by the President—such as not taxing tips and overtime, and increasing the standard deduction.

In terms of spending, the bill plans to reduce spending by $1.3-1.4 trillion over the next decade. Most of this (over $900 billion) is expected to come from the Energy and Commerce Committee, which has sole jurisdiction over Medicaid and joint jurisdiction over Medicare.

The report states that if the Senate does not change the existing wording, the bill seems likely to add approximately $2.5 trillion to the deficit over the next decade (excluding interest expenses).

More concerning is that the newly proposed tax cuts are expected to expire in 2028, making the cost "only" $1 trillion. However, historical experience suggests that Congress is likely to extend these expiring tax cuts in 2029.

The Committee for a Responsible Federal Budget (CFRB) estimates that extending these new tax cuts for another decade—potentially the correct way to conduct this analysis—would add another $1.5 trillion to the U.S. deficit.

This means that the cost of the bill balloons to $4 trillion over the next decade. As interest payments will also rise (with the expiration of low-cost debt), the U.S. debt/GDP situation seems to have "no stable opportunity" in the coming years.

U.S. fiscal situation is not optimistic

According to Barclays' report, in fiscal year 2024, U.S. borrowing is expected to exceed $2.5 trillion, and by fiscal year 2025, this figure seems likely to drop below $2.1 trillion The report states that, numerically, this is an improvement, but this figure is beautified by the fact that the Federal Reserve is reducing quantitative tightening. With the reduction of bonds maturing from the Federal Reserve's balance sheet this year, the Treasury's borrowing needs have superficially improved, along with issues related to changes in the Treasury's cash balance.

After considering these two variables, the report states that the real financing needs of the U.S. Treasury for fiscal year 2025 are close to $2 trillion, slightly higher than for fiscal year 2024.

The report points out that, given that the U.S. tax system is progressive, tax revenues tend to fall short of expectations when economic growth slows. If U.S. economic growth is significantly weaker than last year in 2025, the deficit will further widen.

The report concludes that even without considering the deficit increase brought about by the tax reform bill, the U.S. deficit seems "destined" to account for at least 6.5-7.0% of GDP during good economic times; in the case of an economic recession, the deficit will increase significantly.

Bond Market "Shivering"

The report notes that, despite GDP growth this year certainly being lower than in 2024, U.S. bond yields have risen for several consecutive weeks. This is partly due to concerns about inflation in 2025, partly because foreign investors are shifting some capital away from U.S. assets, and partly because the risk of economic recession seems to have been avoided after tariff easing.

However, part of the reason for the rise in long-term interest rate term premiums may be because the U.S. has not made efforts to control the rising deficit.

The report further points out that the more investors worry about the deficit, the higher long-term interest rates rise, which pushes up future interest payments, in turn leading bond investors to be more concerned—creating a vicious cycle.

U.S. long-term bonds are nearing their highest levels since the global financial crisis. As the market digests the details of the new tax reform bill and realizes that the deficit is likely to continue rising in the foreseeable future, there is also a risk that long-term yields will continue to rise