The second Trump administration has bold fiscal plans, yet it confronts a US deficit and debt situation that raises questions about its capacity to execute them. In contrast to the first term, where it claimed that reduced taxes would stimulate growth and be self-financing, it now encounters the fiscal challenge of prolonging existing tax laws that widen the deficit without boosting growth. Will the Trump administration follow through with its economic plans at the risk of further "bankrupting" the government, which could lead to a notable rise in long-term interest rates and a downgrade of its credit rating, or will it scale back its fiscal ambitions? Finance fuels the economy, but it can also bring it to an end, as demonstrated in 2007-09. Investors may soon realize that government deficits and excessive debt have a greater impact on their personal finances than merely being red ink on paper.
2025 Is Not 2017
In 2025, the second Trump administration takes on a budget deficit nearing $2 trillion, which is three times the $665 billion deficit of 2017, the first year of its initial term. Additionally, US outstanding debt has ballooned to $35 trillion, almost twice the $19 trillion figure of 2017.
Despite the fiscal situation, the Trump administration intends to make permanent the 2017 tax cuts. However, they encounter a fiscal challenge: maintaining the current tax law won't alter the economic growth forecast, but it will deteriorate the fiscal outlook.
The reason is as follows. To alter the economic outlook via changes in tax laws, it's essential to boost cash flow for both individuals and businesses. Merely continuing the current tax laws doesn't improve the financial position of the private sector. Instead, it leads to a substantial budget deficit, totaling $4 trillion over the next ten years, since future budget forecasts assume the 2017 tax cuts will expire at the end of 2025.
Proponents of the Trump fiscal plan would argue that substantial cuts in federal spending are also under consideration. However, the questions remain: what is politically feasible and what is economically viable without causing a recession driven by fiscal policy?
Reports suggest that the Trump administration plans to reduce the federal budget by $2 trillion. However achieving that goal will be politically challenging. Recent data indicates that about 60% of the US federal budget is allocated to "entitlements" (mainly Social Security and Medicare), around 13% is spent on defense, and approximately 13% is used for interest payments on the national debt, comprising a major part of the total budget. That leaves only a small part of the budget to target for large spending cuts.
Implementing significant budget cuts on an agency-by-agency basis would present political challenges. For instance, there have been reports of plans or suggestions to eliminate the education department. It is unclear whether elimination refers to removing personnel or the entire functions. The latter would be politically challenging, if not impossible. The education department's budget represents over 20% of total education spending in the US, supporting millions of students, especially those from low-income backgrounds and communities.
Wall Street will keep a close watch on any measures by the White House or Congress that worsen the US government's deficit and debt issues. . For example, the financial effect of making the 2017 tax law permanent is twice the $2 trillion in budget cuts promised by the Trump administration. This could lead to larger deficits than the $2 trillion annually currently forecasted by the Congressional Budget Office, possibly resulting in increased market rates and a potential credit downgrade.
Critics would contend that the US government cannot go "bankrupt" because it possesses the authority to print money, which is accurate. However, pursuing a "bankrupt" fiscal policy might cause market interest rates to rise significantly (by 100 to 200 basis points or more from current levels), possibly disrupting the economy and causing private businesses to go bankrupt.
Financial realities pose challenges to Trump's Economic agenda. Investors may soon learn that government deficits and excessive debt have a greater impact on their personal finances than merely being red ink on paper.