The Politics Behind the Rising U.S. Debt

Our Head of U.S. Public Policy Research Ariana Salvatore looks at what the midterms may reveal about politician’s appetite for tackling the faster-than-expected increase in the U.S. debt.

Read more insights from Morgan Stanley.

----- Transcript -----

Ariana Salvatore: Welcome to Thoughts on the Market. I'm Ariana Salvatore, Head of U.S. Public Policy Research at Morgan Stanley.

Today, why fiscal is back in focus and what we can learn about the broader debt trajectory from the upcoming midterm elections.

It's Friday, August 28th at 10am in New York.

Fiscal policy has moved back onto investors' radars following Treasury's recent buyback announcements. Those came in the same week that total U.S. debt crossed $ 40 trillion for the first time, a milestone that arrived months earlier than most people expected.

As my colleague Andrew Sheets puts it, that's a big number. But the more useful question isn't the number itself. It's whether all this debt is starting to act as a brake on the economy.

We don't quite yet see a credibility problem in the Treasury market, but that's exactly why fiscal is back in the conversation. And it sits against a bigger backdrop.

The U.S. continues to run large deficits in an economy that isn't in a recession. Our economists expect the deficit to stay around 6 percent of GDP through 2027. And voters are clearly concerned about elevated debt levels.

So why isn't fiscal austerity coming up more in DC? Simply put, we think the political incentives point the other direction.

At the risk of oversimplifying, fiscal consolidation or deficit reduction means either less spending or more taxes. And the political costs of those choices land immediately. We think neither party, therefore, has the incentive to take on that type of policy change – if we don't see a meaningful cliff or a risk to existing programs, especially into an election.

But what about after? We think the midterms won't in and of themselves be a catalyst to fix the debt trajectory. But they can tell us something about where this goes next. And I'd point to two things in particular.

The first is Social Security. It's not likely to be the headline issue in November, but we could see a useful test case for the debt conversation more broadly because the deadline is creeping closer.

The latest trustees report projects the retirement trust fund will become insolvent in the fourth quarter of 2032. And at that point, it could only cover roughly 78 percent of scheduled benefits without a change in law. Now, that's likely to matter more in 2028 than in this cycle, since whoever wins the White House that year will be in office when it hits.

But the midterms can still show us where the politics are consolidating. Recent polling points to a fairly consistent pattern. Voters want lawmakers to act. They prefer raising taxes on high earners over broader benefit cuts. And they're notably more open to trimming benefits when it's targeted at the top of the income distribution.

That likely explains why a number of 2026 candidates have converged on lifting the payroll tax cap, while some Republicans have largely retreated from campaigning on things like a higher retirement age.

Watching which of those messages actually wins, especially in Senate races like New Hampshire or Maine, where a significant share of the electorate depends on these benefits, could provide some useful hints with respect to which of these policy changes actually resonate with voters and end up reflecting the eventual fix.

The second is the broader fiscal landscape after the election. If we get a divided government in November, that typically means more fiscal noise around the recurring deadlines, like government funding and the debt ceiling. Those two matter for markets in very different ways. A shutdown's bigger effect tends to be indirect. So, think delayed or lower quality government data since agencies can end up working from smaller survey samples.

That leaves investors and the Fed making decisions with less complete information for weeks at a stretch sometimes. The debt ceiling is more direct. That shows up most clearly in the Treasury bill market. Bills maturing around a potential deadline tend to cheapen relative to other short-term benchmarks as investors have to price default risk into that narrow window. And that's the case even when a resolution is still the base case.

So, here's the through line: fiscal likely isn't about to become Washington's top priority just because debt crossed $40 trillion. But the midterms are a chance to see whether the political incentives are starting to shift – on Social Security specifically, and on the broader appetite for political fights around funding deadlines more generally.

Either way, we think fiscal policy is set to stay in the headlines in the years to come. And especially so as we head into the 2028 presidential election season.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen. And share your Thoughts on the Market with a friend or colleague today.