Ajay Rajadhyaksha is global chair of research at Barclays. Micheal McLean is a public policy analyst at the bank.
After two years when the US economy seemed to thump everyone else, the narrative is starting to shift.
US stocks are now negative for the year (and are getting hammered by European equities!) the dollar rally has stalled, and bonds have rallied. And this isn’t just a market tantrum; data have started to soften too. The latest bit of bad news was yesterday’s ISM reading, soon followed by more bad tariff news.
The Atlanta Fed’s GDP tracker now suggests a 2.8 per cent economic contraction in the first quarter, after disappointing retail sales, personal spending, consumer confidence and manufacturing data. The nowcasting model has probably been skewed by a surge in imports ahead of tariffs coming into force, but we’re clearly seeing an economic slowdown, which could morph into something more malign.
However, the economic bulls can push back with one simple argument — look, new tax cuts are coming!
After all, the signature legislative accomplishment of the Donald Trump’s first term was the large tax cut in the Tax Cut and Jobs Act (TCJA) of 2017-18. And in recent months, the president has promised not just to extend the expiring TCJA but also to give new tax cuts on tips, overtime pay, Social Security earnings, SALT relief, etc.
Moreover, the House just passed a budget resolution, the first step to a budget reconciliation bill. The Senate has also gotten into the act, with Majority Leader John Thune calling for not just extending the TCJA, but making those cuts permanent. Even if the economy is softening, it seems only a matter of time before Congress rides to its rescue.
Except — the reality on the legislative ground is a little different.
Consider the just-passed House budget resolution. This isn’t a tax bill; it’s a framework that lays out targets for tax cuts ($4.5tn) funding increases ($300bn, mainly for immigration enforcement) and spending cuts ($2tn). Individual committees in the House are then supposed to hit those targets. For example, the Energy and Commerce committee (which oversees Medicaid spending among others) is supposed to come up with $880bn in spending cuts.
Based on this budget resolution, the House can add $4.5tn to the deficit via tax cuts. But House committees have to also come up with $2tn in spending cuts. The original draft didn’t include so many spending cuts, but Republican fiscal hawks on the Budget Committee insisted that they would stop the bill unless those were added. Crucially, every dollar below $2tn gets offset one-to-one by a dollar lower in tax cuts.
Add it all up — $4.8tn in tax cuts and border funding increases and $2tnn in spending cuts elsewhere — and Congress is aiming to increase the deficit by a maximum of $2.8tn. All these numbers are over a decade — from fiscal year 2025 to 2034.
But here’s the problem.
The Joint Committee on Taxation (JCT) estimates that simply extending all expiring tax cuts will add $4tn to the deficit over a decade. But extension is simply a continuation of the status quo — just ensuring that today’s tax bills don’t go up next year. Meaning no new fiscal stimulus. And yet, the current budget resolution targets deficits of $2.8tn. In other words, Congress (currently at least) is not only not planning for large new fiscal stimulus; it is at present targeting a $1.2tn fiscal drag.
There’s also the question of where the $2tn in spending cuts will come from. The Energy and Commerce committee is supposed to come up with almost half these cuts. Medicaid cost the US government $912bn last year and provided health coverage to 67mn people. The natural assumption is that this is where there will be large spending cuts, simply because that’s where there’s large spending.
But the president has ruled out major cuts to Medicaid (in addition to Social Security and Medicare), which begs the question — how do you find $2tn in spending cuts given that defence, interest costs and the troika of Social Security + Medicare + healthcare (Medicaid, Children’s Health Insurance Program and the Affordable Care Act) is what the US government spent almost all of last year’s $6.9tn on?
Separately, what about the new tax cuts that the president has promised? The non-partisan Committee for a Responsible Federal Budget estimates that to fund all of Trump’s tax wishes could add as much as $11.2tn to the deficit over the next decade. A far cry from the $2.8tn deficit increase — and even that just passed the House with the barest 217-215 majority.
In recent days, the Senate has suggested making tax cuts permanent by amending the budget resolution so the Congressional Budget Office (CBO) and Joint Committee on Taxation is told to consider current policy, not current law when ‘scoring’ the bill. This is sausage-making at its finest. Basically, the CBO/JCT no longer has to account for the $4tn or so that it would cost to extend the tax cuts, if the “current policy” guideline is used.
But this is semantics. It doesn’t change the fact that the deficit will still go up by trillions simply if TCJA is extended. Republican House members worried about the deficit still know that the debt clock will rise at a worrying pace — telling the CBO to ignore it doesn’t change the numbers. Notably, the idea of using current policy was also considered at the time of writing the House budget resolution, but didn’t garner enough political support.
There’s one final wrinkle to consider. The assumption we’re making is that all these numbers are over a decade — because that’s what the current language specifies (and a 10-year window is the usual protocol). But the House budget resolution could theoretically be amended so that deficits go up by $4.5tn over (say) five years instead of 10. If so, it opens the door to large new tax cuts.
But that approach also has major problems.
First, if $2tn in spending cuts are incredibly difficult to manage even over a decade (given that the US doesn’t want to touch all the things it actually does spend money on), it’s virtually impossible to squeeze into five years.
Second, if the fiscal hawks are worried about adding $2.8tn to the deficit over a decade, presumably they will be even less thrilled about doing the same over five years.
Markets cheered a few days ago when the House passed the budget resolution. But it doesn’t actually provide for net new stimulus. And there’s a long way to go — and many hurdles to overcome — before it comes close to becoming law. So no one should expect large fiscal stimulus to cushion any looming economic setback.
