America's Fiscal Outlook Takes Its Place On My Watchlist

It's a long-term challenge that's gotten a lot more challenging. But there are things to watch out for this year.

A few days ago, I published a fairly lengthy note listing my hopes and concerns for 2026. One reader asked me why wasn’t the US fiscal outlook on the list? After all, I’ve expressed concern about that in various places.

It’s a fair question and, as I’ll detail here, I remain concerned. Unlike most of the issues I raised in the earlier post, and barring unforeseen shocks, the fiscal trajectory is somewhat baked into the cake, as described by CBOs 10-year outlook. In the near term, at the end of January, Congress will need to pass another budget patch—or shutdown again. But my prior is that they will enact a patch and that will have little impact on the longer-term challenges documented herein.

BLUF: Years of deficit-financed tax cuts have broken the linkage between economic growth and revenue flows to the Treasury. Republicans have, of course, been the most aggressive tax cutters, but Democrats have often extended most of those cuts. Meanwhile, spending on the large social insurance programs is increasingly pressuring the outlook, yet policymakers continue to treat them as untouchable. Also, there’s a good chance that future interest rates will be higher than past ones, making servicing our growing debt a larger burden.

What I want to do today is not go through the longer-term, unsustainability story. That’s well covered by Jessica Riedl here, including a robust, carefully scored set of reform ideas (worth a close read; I don’t agree with everything in there¹; neither does she!). The Committee for a Responsible Federal Budget have had their hair on fire re our debt outlook forever, and their work is always clear, with reliable numbers.

I’ve personally long been on the other side of these arguments—hair not in flames—as I viewed analysis like CRFB’s as advocating a fiscal austerity that would do more harm than good, especially given low interest rates. But, as I wrote about in the NYT recently, these dynamics have changed. Interest rates are higher relative to growth rates, and deficits are concerningly unresponsive to growth.

But for this post, I’ll stick with the things-to-watch-for-in-’26 theme, fiscal outlook edition. To get concrete about it, consider two data points. First, another bad dot. Second, rising term premia. I’ll close with a thought about addressing Social Security’s pending shortfall, as that too is bearing down on us.

Bad Dots

Above I noted that because of the one-way ratchet on taxes—they can only be cut, never raised—my concern that robust growth can no longer be counted on to reduce the deficit as much as it used to. The figure below shows a scatterplot of this dynamic, plotting unemployment rates against the def/GDP ratio from 1962-2025 (fiscal years). The negative slope is clear—stronger economies generate lower deficit ratios, but there’s a conspicuous clump of recent observations in lower-unemp/higher-deficit space.

Those are what I call “bad dots” and I’d wager ‘26 takes up residence in the same neighborhood. It’s a force that makes it harder for growth to help lift us out of our fiscal mess.

Rising Rates

A very good, and inadequately answered, question is what, specifically, should we be worried about regarding our fiscal outlook?² I don’t think anyone who follows this issue thinks the U.S. is vulnerable to a “Liz Truss” moment, wherein global creditors get so spooked by an administration’s budget chicanery that they hit pause on buying their debt. Given the large, liquid market for U.S. debt, along with our dominant currency status, a “sudden stop” seems very unlikely.

But a slow bleed seems less so. That is, lenders may not fear default/non-payment, but they look at our governance, debt-ceiling fights, shutdowns, reckless geopolitical adventurism, and lack of action around the debt itself, and they reasonably want more compensation for their loans to us.

One way we’d see this is in a rising term premium, the extra compensation lenders require to lock their money up for longer-term loans. Below is the term premium on 10-year Treasury debt. As you see, it was negative for about a decade, but is now climbing again. To be sure, that negative span is historically unusual—since when do lenders pay you to lend long?—and the premium is low in historical terms. But it’s climbing, and when you’re carrying $30 trillion (100% of GDP) and rising in sovereign debt, that’s a problem.

Other factors are pushing up interest rates, including demand for AI investments, aging boomers moving from saving to spending mode, less of a global savings glut. Still, no one can forecast interest rates, so this is yet another one of those hope-for-the-best, plan-for-the-worst cases. But a fair assessment of the smart forecasts in this space is that the risks are asymmetric to the upside, i.e., higher future rates.

A Word on Fixing Social Security’s Pending Shortfall

As the excellent Richard Rubin tells us in the WSJ this AM:

After years of Congress sidestepping and postponing the issue, the lawmakers will have to confront the program’s challenges before their new six-year terms conclude. Recent projections pegged late 2032 as the moment when Social Security’s reserves and incoming tax revenue won’t yield enough money to pay full benefits.

…

Social Security’s day of reckoning has long been seen as an issue for future presidents and Congresses. But the cliff is now entering the political calendar, pulled forward by the pandemic’s ripple effects and Congress’s decisions to expand benefits and cut income taxes that help fund Social Security.

This often gets misinterpreted as benefits won’t be paid out starting then. That’s false, as payroll taxes will support 75% of scheduled benefits, but that’s still a huge cut and a terrible outcome that must be avoided.

Its avoidance will require both benefit cuts and tax increases. Progressives persuasively call for raising the tax cap on earnings. Before inequality took off, just 10% of benefits were above the cap; now, it’s 17%. I’ve also always thought that as non-wage compensation (untaxed by the payroll tax) grew relative to wages, those dollars should be added to the base.

But reducing the benefits that go to the wealthiest recipients also should be on the table. I’ll use myself as an e.g., as having just turned 70, I just filled out the forms to start benefit payments. I’ve spent the vast majority of my working life in the non-prof, gov’t sectors, so I’m no tech billionaire, but like the almost all of my peers, income-wise, I saved for retirement outside of Social Security. I won’t reveal my monthly payment and I’ll be very happy to get it. But I’d be very happy, and perfectly financially sound, to get less than that, which is decidedly not the case for less fortunate members of my aged cohort.

More to come on all of this as the year unfolds. The economics, as explained above, are much easier to lay out than the politics, so I’ll try to help with that too.

1. EG, I worry that “premium support”—giving people money to shop for health coverage and hoping that gins up cost-saving competition—leads to adverse selection (insurers avoiding covering higher-risk persons) and two-tiered coverage.

2. Riedl is an exception here, providing an extended take on how the risks of unsustainability could play out (see “How a Debt Crisis Might Play Out”).