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Why Donald Trump’s Tax Cuts Could Lead to Economic Trouble

Donald Trump speaking with supporters at a campaign rally at the Phoenix Convention Center in Phoenix, Arizona. Image Credit: Gage Skidmore.
Donald Trump speaking with supporters at a campaign rally at the Phoenix Convention Center in Phoenix, Arizona.

On Monday of next week, Donald Trump will begin his second term in the White House against several indicators that suggest that now is not the time for budget policy recklessness. We hope Mr. Trump is paying close attention to those indicators. Maybe he will then walk back some of the budget-busting tax-cut proposals he kept making on the campaign trail. If he does not, we should brace ourselves for rough economic sledding this year.

Start with inflation. Today’s consumer price inflation numbers show that stripping out the volatile food and energy components from the index, inflation is running at 3.2 percent. This remains uncomfortably above the Federal Reserve’s 2 percent inflation target.

This suggests that if the Fed resumes its interest rate-cutting cycle, it will need support to curb demand through budget policy restraint. Yet this is hardly what Mr. Trump has in mind with his promises of an array of tax cuts, including the 2017 Tax Cut and Jobs Act extension and the elimination of income taxes on social security benefits and tips.

Recent budget deficit numbers also seem to be screaming for budget policy restraint. Those numbers show that the budget deficit for the first three months of the 2025 fiscal year was almost 40 percent higher than last year.

Meanwhile, the Congressional Budget Office (CBO) estimates that in 2024, the budget deficit was 6 ½ percent of GDP, even when unemployment remained close to its postwar low. The CBO is also warning that even before taking the budget impact of Mr. Trump’s tax cuts into account, by 2034, the national debt about the size of the economy is on track to exceed its end of the Second World War level.

If Mr. Trump is not paying attention to the dangerous debt path on which our country finds itself, the bond market is fully alert to those dangers. Since Mr. Trump looked increasingly likely to win the election in September, the all-important 10-year Treasury bond yield has spiked from 3.6 percent to 4.8 percent.

It seems not to have escaped the market’s notice that Mr. Trump’s tax cut proposals would cause a substantial deterioration in our country’s public finances. According to the Committee for a Responsible Budget, Mr. Trump’s tax cut proposals would add $7 ¾ trillion to the budget deficit if fully implemented over the next decade. That, in turn, would see the national debt exceed a Greek-like 140 percent of GDP by 2034.

Yet another reason for budget restraint is our gaping trade deficit, which is now running more than 3 percent of GDP. At a time when the country is already the world’s largest debtor country, the last thing we need is a budget policy that furthers our trade deficit by exacerbating our savings-investment imbalance.

Yet that is what the Trump tax cut policy would do by reducing government savings and by incentivizing investment.

In 2022, Liz Truss, the then UK prime minister, threw caution to the wind by introducing an expansive budget not to the market’s liking. The bond market and currency market crisis that ensued cost Ms. Truss her job.

Let us hope that Mr. Trump’s advisors draw Mr. Trump’s attention to that recent UK experience. Maybe then Mr. Trump will scale down his tax cut proposals and spare us from our own bond market crisis.

About the Author: Desmond Lachman 

American Enterprise Institute senior fellow Desmond Lachman was a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging-market economic strategist at Salomon Smith Barney.   

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Desmond Lachman joined AEI after serving as a managing director and chief emerging market economic strategist at Salomon Smith Barney. He previously served as deputy director in the International Monetary Fund’s (IMF) Policy Development and Review Department and was active in staff formulation of IMF policies. Mr. Lachman has written extensively on the global economic crisis, the U.S. housing market bust, the U.S. dollar, and the strains in the euro area. At AEI, Mr. Lachman is focused on the global macroeconomy, global currency issues, and multilateral lending agencies.

4 Comments

4 Comments

  1. Greg Versace

    January 15, 2025 at 1:37 pm

    The author has no concept of governments reducing spending.

  2. Webej

    January 15, 2025 at 7:24 pm

    The 2% “target” was originally stated as a ceiling for monetary policy.

    The law mandates prices stability.
    My suggestion is that if you boat lists 2% more each year, your boat is not stable.

  3. NewYear2025

    January 16, 2025 at 4:33 am

    Trump could collect a lot of extra money by setting up a US tariff revenue agency aimed at squeezing cash from foreign countries that employ massive numbers of diplomatic staff abroad.

    Countries like UK, germany, france and china have massive armies of diplomatic service employees serving abroad.

    Just calculate the exact number and put a suitable tariff on them.

    Say, $500 million per year.

    Come on trump. And get schedule F cracking also.

  4. Webej

    January 16, 2025 at 1:32 pm

    @NewYear2025 Setting a tax of M$500 on diplomats would achieve nothing, except countries would withdraw their diplomats. Since those diplomats need housing and spend money, it would be a net loss for the economy, and they would all kick out American diplomats.

    Contrary to what Trump and others keep saying, tariffs are not paid by foreign producers but by domestic consumers. Trade deficits are not a subsidy to other countries, but means you are buying other people’s stuff on credit and you yourself are not producing stuff other people want to buy. O. And the Chinese do not unfairly subsidize their exports. Think of how the Chinese could possibly be getting richer by giving away stuff for free (or less than it costs to produce).

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