RPT-BREAKINGVIEWS-Iran conflict is fresh threat to US fiscal future

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

By Gabriel Rubin

WASHINGTON, March 5 (Reuters Breakingviews) - War is the time for budget deficits, while peace is the time to pay the bills. Unfortunately, the United States government has been spending as if it were at war for several years. Now that President Donald Trump has attacked Iran, there’s little fiscal space to pay for weapons and soften the effects of supply chain disruptions. Worse still: the Supreme Court has struck down tariff revenue, while higher-for-longer interest rates mean the U.S. faces a heavier burden from servicing its debt. Those are the ingredients of a sovereign debt spiral, one that policymakers ignore at their peril.

The U.S. starts the conflict in an exceptionally poor fiscal position. Its budget deficit equaled 5.8% of GDP in 2025, higher than the 50-year average of 3.8%, per the Congressional Budget Office. The nonpartisan agency expects federal debt to balloon from 99% of GDP last year to 120% by 2036 — surpassing the all-time peak of 106% of national output reached immediately after World War Two. An extended conflict in the Middle East will exacerbate those pre-existing conditions.

The administration has already suffered a poorly timed revenue shock from last month's Supreme Court ruling, rejecting the administration’s emergency global tariffs which had taken in an estimated $175 billion. Trump has spoken of income from trade levies as a future replacement for income taxes. While far-fetched, this underscored their importance as a revenue source. The money has already been spent, and then some: the president's 2025 tax law will add $4.7 trillion to U.S. deficits over the 10-year budget window. Annual appropriations will likely swell to account for new war spending, with an initial $50 billion request from the White House to be debated in Congress soon. The government will also gain little from exporting more expensiveoil: producers pay a flat rate per barrel, regardless of price, while a windfall profit tax ended in 1988.

The Federal Reserve cannot be an ally to the administration. The recent memory of supply shock-induced price rises following the pandemic and Russia's invasion of Ukraine means central bankers have no desire to tolerate higher inflation. The Fed will seek to tamp down price pressures, suppressing investment. Though futures markets have priced in two 25-basis-point cuts to official rates this year, a chorus of Fed officials in recent days have sounded wary of wartime shortages and price spirals.

A swift end to the conflict would limit the fiscal damage. But higher rates and increased deficit spending will, over time, add to the interest burden on U.S. sovereign debt. Prior to the attack on Iran, the CBO estimated that interest costs were set to more than double to $2 trillion in the decade to the fiscal year ending in September 2035. The hole keeps getting deeper, even as the shovels keep digging faster.

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CONTEXT NEWS

An open-ended conflict between the United States and Iran could spill back onto the U.S. economy through falling asset prices, a trade shock to allies, and higher inflation, at least in the near term, New York Federal Reserve President John Williams said on March 3.

The U.S. budget deficit will grow slightly in fiscal 2026 to $1.9 trillion, the Congressional Budget Office forecast in February, showing that on balance, President Donald Trump's economic policies are worsening the country's fiscal picture amid low economic growth.

(Editing by Jonathan Guilford; Production by Pranav Kiran)

((For previous columns by the author, Reuters customers can click on RUBIN/gabriel.rubin@thomsonreuters.com))