The Iran War has now extended beyond the 4-6 weeks that President Trump originally projected, so the “tail risks” of prolonged war become ever more apparent. Those risks are fairly small at this stage, but as the war continues, its out-of-pocket costs will increase arithmetically, but its economic and fiscal downside risks will increase geometrically. I will explain why this is so, in the hope that future Presidents will finally learn from this and avoid getting themselves into wars in the Middle East, however persuasive the hawks and neocons may be.
The Iran war is currently estimated to have cost some $60 billion over its 50-day life, but its long-term costs would be at least double that, even if it were to end tomorrow. Not only does very expensive U.S. armament and ammunition have to be replaced, but the pensions, veterans’ benefits and disability costs of the soldiers and support staff will add a tail of long-term costs that will double the up-front costs of their deployment. $100 billion is thus almost certainly too low as an estimate of the 50 days of war’s total costs, although $200 billion is probably too high.
If the war drags on, it can be expected to add some $20-40 billion in cost every ten days, with a truly prolonged deployment pushing towards the higher end of that range as additional “rush” orders for ammunition will be needed, and some equipment will be destroyed and must be replaced immediately, rather than on the normal schedule, which will add greatly to its cost.
If the U.S. were running close to a balanced budget, this would not be a major problem – even $400 billion is only about 9% of the year’s Federal revenue, or 1.3% of GDP, so could be easily financed, as were regional wars in past eras. The problem is that according to recent Treasury figures for the October-March period, the Budget deficit for the first half of the year to September 2026 was $1.17 trillion, lower than in the last months of the profligate Biden era but suggesting that the full year’s deficit will be at least $2 trillion, yet another year, the fifth in the last six where it has run close to or above this dangerous level.
On the revenue side, decent economic performance has increased personal income taxes, and tariffs are making a very significant contribution, $167 billion in the six months, or probably around $350 billion in a full year. The problem is corporate taxes, which in a year of solid growth and record corporate profits were down by 28% from the previous year, a shortfall of $45 billion for the six months or close to $100 billion in a full year. Contrary to the whining in the liberal press, the One Big Beautiful Bill Act last summer did not give too much away on individual taxes (the individual income tax yield was up a healthy 9% from the previous year) but it allowed the corporate lobbyists to get away with murder. In particular, they were given immediate expensing of capital equipment (such as the ubiquitous data centers, whose tax breaks are almost certainly leading to massive overbuilding) that economically lasts for 5 years or longer, and should be depreciated over its useful life, as we were all taught in business school.
The lobbyists for big corporations always see a Republican administration as a license to exercise their prerogative of unlimited and unjustified greed. One had hoped that the arrival of an intelligently populist second Trump administration would counter this, but as in the 2017 tax act the greed of big corporations has been allowed to override the need to balance the budget or the burdens on more modestly remunerated companies and citizens.
In the year to September 1996, corporate taxes totaled $172 billion, 11.8% of total government receipts or 2.1% of 1996 GDP of $8.2 trillion. This year corporate taxes will yield only 4.9% of total tax receipts or about 0.7% of 2026 GDP. Corporate profits are higher in real terms now than they were in 1996; it is thus a disgrace that large corporations have been allowed to get away with sloughing off about two thirds of their appropriate tax liability on the long-suffering public or their smaller brethren. Dozy Republican legislators pass these grotesque handouts to the giant monopolistic multinationals and then wonder why their “tax cutting” budgets are not better rewarded by the hard-pressed electorate.
With deficits already far too large, public debt soaring rapidly past 120% of GDP and the “Social Security Trust Fund” emptying around 2033, the strain on the U.S. fiscal position is great and another $400 billion from a medium sized war will make it even greater. The cost of this will not come in immediate default, but in an increasing cost and difficulty of the U.S. Treasury raising new debt, especially with a long-term maturity. At some point, the succession of deficits will cause the U.S. fiscal position to enter a “death spiral” of higher borrowing costs and restricted investor appetite, leading to inevitable default and destruction.
The Fed is attempting to prevent this happening, by starting a new round of “quantitative easing” bond purchases of $40 billion per month in December 2025. These purchases artificially hold down long-term yields, albeit at the cost of stoking inflation and restricting bank lending to small businesses, since the purchases are funded by massive deposits with the Fed from the banking system. The Fed’s balance sheet, currently around $6.5 trillion, is also blown up by these purchases; when the inevitable inflationary surge occurs and the bond market raises interest rates to counter it, the Fed will suffer yet more huge losses on its bond holdings on top of the $210 billion already accumulated, which will form yet another burden on unfortunate U.S. taxpayers.
The current game of the Fed balancing the bond market against the effect of huge budget deficits by buying long-term Treasuries (totally contrary to all sound principles of central banking) cannot last forever and its vulnerability is already indicated by the behavior of the TIPS (Treasury Inflation Protected Securities) market. Here the yield on long-term TIPS, with maturities of 2048 or later, is consistently above 2.6% and on many days reaches 2.7%. That is a much higher yield than has ever been seen in the history of this market (at least, for the last 25 years since the market has been mature) – for most of the 2012-22 period market yields here were well below 1%, as the Fed was buying aggressively here, too.
Such high yields have serious implications for the cost of financing U.S. debt in the future, since they represent real yields, the nearest we have to a “Gold Standard” bond yield. There is also a notable yield curve; bonds with maturities of 10 years or less yield at most 1.8%. This suggests the high yields at the long end of the curve reflect a substantial default risk – the market thinks there is little chance of the U.S. Treasury defaulting before 2036, but a much higher chance of a default by 2048 or later.
Since nominal 30-year bonds yield only 4.85%, the assumed rate of inflation over the next 30 years is a mere 2.2% — with the Fed inflation target at 2% and the misses being all on the high inflation side, this is far too low a level. Once the Fed stops buying bonds (which it should do as soon as possible), the true expected rate of inflation and the true expectation of default will be built into long-term rates, pushing the 30-year Treasury yield to around 6%, even if the temporary blip in inflation produced by the Iran War has not embedded itself into the system. The budgetary implications for such high financing costs are dire.
There are several things the Treasury can do to alleviate this problem, put U.S. government debt on a sound long-term basis, and remove the default risk from long-term Treasuries. It can avoid both excessive defense spending and new wars. It can fight fraud and waste aggressively, making sure that last year’s defunding of USAID and Planned Parenthood is held in place and reaming out the Medicaid and food stamps programs. It can codify tariffs into the revenue base, so that they yield a steady and increasing $400 billion a year – the Treasury needs the money and it is monstrous that individuals should be expected to bear more and more of the burden of the state’s profligacy. (In this context, the Supreme Court forcing the government to refund Trump’s initial tariffs to large multinationals but not to consumers is yet another grotesque bias of the system in favor of the politically powerful and against ordinary people.) In this context, Treasury should also return corporate tax to around its 1996 level, in terms of GDP – an annual yield from large corporations of $650 billion rather than $200 billion will make a very useful dent in the deficit.
Finally, the Treasury can remove all the tax benefits currently received by the odious “nonprofit” sector, which currently represents around 6% of GDP — the charitable tax deductions for billionaires are an especially noxious loophole in the system and tax relief for non-profits is a huge subsidy to the destructive Left. Drastically shrinking the non-profit sector will greatly sweeten our political dialogue and increase the productivity of the economy, as well as yielding some $450 billion (25% of 6% of GDP) annually to the Treasury. Together with tariffs and proper corporate taxes, it will go a long way to closing the Budget deficits that imperil the future of us all.
The Iran War was a mistake; we all make them. Using the crisis in U.S. finances which it will exacerbate to solve the fiscal problem once and for all will enable the U.S. to prosper greatly and achieve a strength that makes further such wars utterly unnecessary.
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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)