Last Tuesday, the S&P 500 closed at 7,818.93, marking its first closing record high since August 13, with a weekly gain of 1.2%. On Wednesday, the yield on the 10-year U.S. Treasury auctioned at 5.30%, a new high in 24 years.

On Thursday, the Congressional Budget Office (CBO) released its ledger for fiscal year 2026: revenue of $5.40 trillion, spending of $7.40 trillion, and a deficit of $1.99 trillion; net interest stood at $1.14 trillion, exceeding defense spending by $227 billion.

The deficit accounts for 6.2% of GDP, while the unemployment rate is 4.2%. There is no war on home soil, nor a recession. Maya MacGuineas, head of the Committee for a Responsible Federal Budget, described this figure as 'the highest in history outside of war and recession.' Consequently, many headlines this week have been asking the same question: Can the U.S. government still hold up?

Lay out the ledger, and the answer lies in two lines on the revenue side and two on the spending side.

Individuals Are Paying Taxes

The largest line item on the revenue side is individual income tax: rising from $2.66 trillion to $2.84 trillion, an increase of $188 billion, or 7%. Breaking it down, withholding from wages increased by $168 billion (+5%), reflecting higher wages and bonuses; voluntary payments upon filing rose by $108 billion (+9%), driven by capital gains from selling stocks and options. Payroll taxes also saw an additional collection of $67 billion.

Wages, bonuses, and stock gains are all being taxed; the wealth effect of AI has landed on individual tax bills.

NVIDIA's market cap is approaching $6 trillion, and Micron has nearly tripled this year. When employees' restricted stock units vest, they are withheld like wages; when shareholders realize gains, they must prepay taxes. The Treasury is one of the biggest shareholders in this rally.

Companies Are Building Factories

The steepest decline on the revenue side is corporate income tax: dropping from $452 billion to $382 billion, a shortfall of $70 billion (-16%). The CBO's explanation is succinct: corporate profits are rising, but the 2025 tax cut law allows companies to deduct specific investments in a lump sum. Signed into law on July 4 last year, this legislation permanently made 100% expensing of equipment investment current-year deductible.

Microsoft is the most typical case study. In FY2026, its pre-tax profit in the U.S. was approximately $101 billion, up from a previous record of $65 billion. At the statutory 21% rate, federal income tax should have been around $21.2 billion, but the actual payment was only $2.46 billion, resulting in an effective tax rate of just 2.4%. Of the $1.87 billion saved, about two-thirds came from accelerated depreciation on investments. That same year, Microsoft's capital expenditure reached $115.9 billion, up 80% year-over-year, with two-thirds spent on servers and GPUs—assets eligible for immediate deduction. Another footprint on the cash flow statement: deferred taxes were positive $9.5 billion in the first nine months, compared to negative $4.8 billion in the same period last year.

In plain terms, the government is letting companies keep the taxes they would normally pay in hand to build data centers now, collecting the tax later. This is policy design, not a loophole.

The $70 billion shortfall in corporate tax and the $188 billion surplus in individual tax are two sides of the same coin: one side is building AI, the other is distributing AI's dividends.

The tariff line is also worth a glance: $22 billion less collected. After the Supreme Court ruled emergency tariffs illegal in February, the Treasury began refunding duties starting in May, returning approximately $130 billion this fiscal year. Tariffs, which account for 3% of total revenue, are currently being clawed back.

Interest Outpaces Defense

The fastest-growing major item on the spending side is net interest: rising from $1.03 trillion to $1.14 trillion, an increase of $115 billion (+11%). The CBO's explanation is again brief: more debt, higher long-end rates, and lower short-end rates only partially offset the impact.

What scale is $1.14 trillion? Defense spending is $916 billion; interest exceeds defense by $227 billion, marking the third consecutive year it has surpassed defense. For every $100 spent, $15 goes to interest. Interest as a share of GDP reached 3.3% last year, surpassing the 1991 peak of 3.2%.

More critically, consider the direction. Total federal debt stands at $40.1 trillion by the end of this fiscal year, with $32.4 trillion held by the public. The average interest rate on outstanding debt was 3.45% in July, the highest since 2009; new 10-year issues are at 5.30%. The batch of Treasuries issued between 2020 and 2022 with coupons under 1.5% are maturing one by one, being replaced by new debt at around 5%. The slope of the interest bill is determined by the rate at maturity and rollover, not by the total amount owed.

This is the source of 'the enemy is the interest rate.' A $2 trillion deficit must be filled by issuing debt; issuing debt pushes up long-end rates; higher long-end rates increase interest costs; higher interest costs widen the deficit. During the October 7 10-year auction, indirect buyers took 80% of the allocation, with the yield 1.7 basis points lower than the pre-issue benchmark. Buyers are present, but their price demands keep rising. U.S. credit is not the problem; price is.

The rate paid by the Treasury and the discount rate applied to earnings by the stock market are the same rate.

Who Serves, Who Gains More

Another line item on the spending side rose by 10%: the Department of Veterans Affairs, increasing from $377 billion to $416 billion. The CBO attributes this to more beneficiaries receiving larger payouts.

The increase stems from the 2022 PACT Act: 23 diseases linked to toxic exposure are now presumptive conditions, meaning veterans no longer need to prove causation. The number of recipients of disability compensation rose from 5 million in 2020 to nearly 6 million in 2024, comprising one-third of the 18 million veterans; per capita annual compensation increased from $18,000 to $25,500; total disability compensation surged from $91 billion to $153 billion. This fiscal year, the VA processed over 3 million disability claims, breaking records in the second year, reducing backlog by 70%, and disbursing over $207 billion in compensation and pensions. Benefits will be adjusted upward by another 2.8% in 2026.

$416 billion is nearly half of defense spending. I am willing to view this money as a different kind of defense: those who serve the nation receive tangible benefits. This is not just lip service; it is an investment in national cohesion, with a long accounting period and long-term returns.

Unsustainable?

There are two types of bankruptcy: one where no one lends you money, and another where you can borrow, but it gets increasingly expensive. The U.S. is the latter.

The last time interest as a share of GDP stood above 3% was from the late 1980s to the mid-1990s. The way out of that cycle wasn't achieved through austerity: the internet investment boom pushed up both productivity and capital gains, raising individual income tax as a share of GDP from 7.6% in 1992 to 10.2% in 2000, turning the federal budget into a surplus in 1998. The mountain of interest wasn't moved; it was dwarfed as both numerator and denominator grew.

Today's ledger bets on the same outcome. The $70 billion in corporate taxes foregone has become data centers; the $188 billion in additional individual taxes is the first dividend of the AI wealth effect. Fiscal policy and the stock market are betting on the same thing: AI-driven productivity must materialize before interest compounding snowballs out of control.

Both conditions are indispensable. First, AI must actually generate profits; deferred taxes today must turn into profits and tax revenues tomorrow, visible in earnings reports. Second, interest rates must fall, preventing rollover rates from climbing further, dependent on oil prices and the Fed. Beyond these two conditions, there is one uncontrollable risk: with a 6.2% deficit at a 4.2% unemployment rate, a recession would cause revenues to drop first, while interest costs won't wait.

Thus, 'unsustainable' is the wrong question. The real question is: what will the interest rate be at the moment of refinancing?

Highlighting risks does not mean being bearish; pullbacks are opportunities to enter.

Next Week: Watch CPI First

Wednesday's September CPI print, with market expectations at 3.6% headline and 2.5% core, will determine whether rates are hiked in December, thereby setting the baseline interest rate for next year's interest bill. Tuesday and Wednesday feature earnings from six major banks; Thursday brings TSMC results. The former signals credit trends, the latter the AI earnings numerator. The Treasury's official final settlement will also be published in mid-October, with figures slightly differing from the CBO's preliminary estimates.

[Next Week Outlook]

Next week's U.S. equities will hinge on the two ends of the interest rate curve: what the Treasury pays and what the market discounts.

Last week's cards: S&P hits a seven-week closing high, 10-year yield at 5.30%, deficit at $2 trillion, interest breaks $1 trillion.

Next week's table: Wednesday CPI, Tuesday/Wednesday bank earnings, Thursday TSMC.

Earnings determine the numerator; CPI determines the denominator.

Until rates retreat, do not chase highs; before AI chain earnings are disproven, do not exit positions. The watchlist and position sizing are available on the website.

Ultimately, deficits are political; interest rates are market-driven. Politics can delay, but markets do not wait.