Tax Day: What April tells us about the deficit

April's tax receipts give the bond market its clearest read of the year on federal revenue, which is why Tax Day matters more to Treasury desks than to accountants. The Congressional Budget Office expects a full-year deficit of $1.5 trillion, and fixed-income traders are watching the Treasury's cash receipts to see whether borrowing estimates will have to go up again.

Why one month carries the weight

April is when individual tax settlements for the previous year arrive in a lump, alongside the first estimated payments for the current one. Withholding from wages tracks payrolls and is easy to forecast. Final settlements depend on bonuses, dividends and, above all, realized capital gains, which are not. A single month can therefore move the Treasury's cash position by a wide margin, and primary dealers rewrite their issuance models once the figures are in.

Last year showed how badly April can disappoint. Stocks and bonds both fell hard in 2022, so the gains that would normally have been taxed the following spring did not exist. The IRS also postponed filing deadlines for most of California until October after winter storms, pushing a large slice of receipts out of the spring altogether. Revenue fell short, the fiscal 2023 deficit came in at about $1.7 trillion, and the Treasury had to raise its borrowing estimates in the middle of the year, which helped set off last summer's bond sell-off.

Capital gains help, briefly

Strong markets in 2023 lifted capital gains tax receipts, which spared the Treasury an immediate cash squeeze. The S&P 500 gained about 24 per cent over the year, and the realizations that followed are what fill the April post. The relief will not last. Mandatory entitlement spending keeps compounding, and net interest expense has passed $800 billion a year. For a peacetime economy at full employment, a deficit of this size has few precedents in American history.

The comparison matters because deficits normally shrink when unemployment is low. Large gaps in the past came with wars or recessions: the Second World War, the financial crisis of 2008 and the pandemic. With joblessness below four per cent, the cyclical cushion that usually narrows the deficit in good years is already spent, which leaves the next downturn to start from a much weaker fiscal position than the last one did.

How the cash moves

The mechanics run through the Treasury General Account, the government's current account at the Federal Reserve. When April payments land, the balance swells and the Treasury can trim the supply of short-dated bills for a few weeks, which is why bill yields often soften against other money-market rates in late spring. The effect reverses by summer as spending resumes its normal pace. Coupon issuance, the notes and bonds that set long-term yields, is decided separately at the quarterly refunding, and a good April does little to change it.

That is where the structural problem shows. In February the Treasury told dealers it did not expect to raise coupon auction sizes for at least the next several quarters, after lifting them repeatedly through the second half of 2023. The pause holds only if revenue behaves. A deficit near $1.5 trillion has to be financed somewhere, and if bills keep absorbing the gap, their share of outstanding debt drifts further above the 15 to 20 per cent range that the Treasury's own borrowing advisers have long recommended.

Interest on the interest

Net interest is the part of the deficit that the tax calendar cannot touch. The Fed's benchmark rate has sat at 5.25 to 5.50 per cent since last July, and every note issued in the near-zero years of 2020 and 2021 is being refinanced at several times its original coupon. Because the average maturity of marketable debt is only about six years, higher rates feed into the interest bill steadily rather than all at once, and they will keep feeding in for some time even after the Fed starts cutting.

Fiscal politics offers no obvious relief. Most of the individual tax cuts in the 2017 Tax Cuts and Jobs Act run only until the end of 2025, and extending them without offsets would add heavily to future deficits. Neither presidential campaign has proposed serious cuts to Social Security or Medicare, the programmes driving the mandatory total. Fitch removed the country's AAA rating last August, pointing to the debt burden and repeated standoffs over the debt ceiling, and Moody's moved its outlook to negative in November.

The case for calm

The strongest counterargument is that none of this has stopped the market from absorbing supply. Auctions have mostly cleared without trouble, the dollar remains the world's main reserve currency, and nominal growth of more than six per cent last year kept the debt ratio from rising as fast as the headline deficit implies. Japan has carried far higher public debt for decades without a buyers' strike.

The weakness in that argument lies in price rather than access. The United States will always find buyers for its debt; the open question is the yield they require. The term premium on long Treasuries, which spent most of the past decade near or below zero, turned positive during last autumn's sell-off, when the ten-year yield briefly touched five per cent. Nominal growth also flatters the debt ratio only while inflation runs hot, and the Fed is trying to stop exactly that.

The costs of heavier long-dated supply also fall unevenly. Holders of duration, from pension funds to regional banks still nursing unrealized losses from 2022, carry the price risk, while households feel it through mortgage rates that key off the ten-year yield. Money-market funds are the relative winners, collecting more than five per cent on the bills the Treasury keeps issuing to plug the gap.

What comes after April

The next test is the quarterly refunding in early May, when the Treasury publishes borrowing estimates for the coming months alongside its auction plans. The monthly Treasury statement for April will show how large the surplus actually was. Beyond that, the CBO's next baseline update and the campaigns' tax pledges will matter more to long yields than any single month of receipts.

A good April buys the Treasury a little comfort and changes nothing else. The deficit will keep pushing a steady stream of long-dated debt onto the market for years, and bond investors will probably demand higher yields to take it, starting with the refunding in early May.