President Donald Trump, members of his administration, and Republican members of Congress talk a lot about reducing the federal deficit. Unfortunately, their words are empty of substance. What matters to the long-term fiscal and economic health of the nation is enacting legislation to reduce the deficit. But the Republican Party’s major legislative effort, a giant reconciliation bill, will increase the federal deficit over both the short term and well into the future.
In addition, some of Trump’s current executive actions will result in slower economic growth, modestly higher inflation, and put further upward pressure on interest rates. Very importantly, the fastest-rising expense for the federal government is servicing the existing federal debt. Today, the net federal debt is about 100% of GDP. This means that each 1% increase in borrowing costs by the federal government increases the federal deficit by 1% of GDP.
The Republican majorities in both the Senate and the House of Representatives are working on extending the individual tax cuts which were enacted into law as part of the Tax Cuts and Jobs Act of 2017. There is a high probability that the tax cuts will be extended as the tax provisions of the TCJA can be passed according to the Budget Reconciliation procedure, which only requires a majority vote in each body of Congress. Republicans are the majority party in both the Senate and the House; extending the tax cuts is almost a done deal.
Current deficit estimates for both the next few years and for out years assume that the tax cuts expire. When the tax provisions of the 2017 TCJA do not expire but rather are extended, deficit projections will immediately increase. In a letter to Republican congressman David Schweikert, the Congressional Budget Office explained that if the individual tax cuts of the TCJA are extended then federal debt held by the public increases from the current 99% of GDP to 166% of GDP by 2054.
The Committee for a Responsible Federal Budget adds: “that extending the TCJA would add over $37 trillion to the debt over the next 30 years, including $4.5 trillion over the next ten years and $15.0 trillion over the next 20 years.”
In other words, any talk about reducing the deficit is just nonsense.
Some may ask, “What about the Department of Government Efficiency, DOGE? Won’t the actions of DOGE reduce the deficit? The truth is that in the context of $30 trillion of net federal debt held by the public, under a best-case scenario, DOGE will cut the deficit by billions when true fiscal restraint requires trillions in spending cuts. Elon Musk claims savings of $105 billion, but that number is full of holes. Experts say DOGE’s savings are inflated.
But for the sake of argument, let’s accept the claim of $105 billion in savings. Unfortunately, for the first five months of the current fiscal year for the federal government, the federal deficit is about $1 trillion. Very importantly, the Treasury market is skeptical that DOGE is having a meaningful impact on the federal deficit. Treasury yields have traded without volatility since Trump was elected and since DOGE was initiated.
If DOGE cuts were meaningful, borrowing costs for the federal government would be falling. A recent National Bureau of Economic Research paper explains that changes in projections for the federal deficit are immediately reflected in changes in Treasury yields. The researchers explain: “that a 1% point one-time increase in deficits/GDP increases the 10-year nominal yield by 0.75 bps. This effect is equivalent to a 6.75 bps increase in yields for a persistent shock to deficits.”
Obviously, extending the tax cuts will raise Treasury yields which means higher borrowing costs, rising deficits, lower business investment and pressure on the mortgage market. Extending the tax cuts is not the only reason why deficits will increase under the Trump Administration, however.
His tariffs create economic friction and reduce growth. Lower GDP growth translates into lower tax revenues and higher deficits. Trump’s tariffs are inflationary which means that the Federal Open Market Committee, the rate-settling body of the Federal Reserve Board of Governors, will be unlikely to reduce interest rates.
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Finally, Trump’s willingness to decouple from the TransAtlantic Alliance and his seeming embrace of President Vladimir Putin of Russia has caused Germany, the major economy of Europe, to resort to fiscal stimulus in order to increase defense spending. German fiscal stimulus is raising global borrowing costs for the world’s major economies, including the United States.
Domestically and internationally, Trump and his Republican Party are pursuing policies that will increase the deficit. It’s dishonest to suggest otherwise.
James Rogan is a former U.S. foreign service officer who later worked in finance and law for 30 years. He writes a daily note on the markets, politics, and society. He can be reached at [email protected].