According to a report released last Friday by the Congressional Budget Office, even under the most favorable conditions, implementing this series of policies will be challenging.
Trump is set to enter the White House with grand plans, including making his 2017 tax cuts permanent, addressing a generation's immigration crisis, strengthening the military, and reshaping global trade through tariffs and aggressive negotiations.
According to a report released last Friday by the Congressional Budget Office, even under the most favorable conditions, implementing this series of policies will be difficult. This is especially true as Trump's second administration will have to pursue these goals against the backdrop of historically high budget deficits, which are projected to increase in the coming years.
The Congressional Budget Office stated that the U.S. budget deficit is expected to reach $1.9 trillion by 2025, accounting for 6.4% of GDP—both record levels outside of wartime, the COVID-19 pandemic, and economic recessions. The deficit is only expected to grow from here, potentially reaching $2.7 trillion by 2035.
As mandatory spending on programs like Medicaid, Medicare, and Social Security grows faster than revenue, the total federal debt will also rise significantly. Forecasts indicate that by 2029, the last year of Trump's term, the publicly held federal debt will exceed a historical record of 106.1% of GDP, previously set at the end of World War II. The Congressional Budget Office expects this ratio to continue rising, reaching 118% of GDP by 2035.
The economic and political consequences of this situation could pose significant challenges for the new administration. "From any perspective, we are on an unsustainable fiscal path," said Michael A. Peterson, CEO of the Peter G. Peterson Foundation, which advocates for reducing government budget deficits.
Peterson noted that the recent upward trend in U.S. Treasury yields during the Fed's rate-cutting period is an "unusual dynamic" that reflects "market concerns about future debt and inflation." Economists say that one of the drivers of post-COVID inflation, and part of the reason Biden struggles to win a second term, is the high level of government deficits.
The deficit could undermine the Fed rate cut, a policy that has received public support from Trump. Bank of America economist Claudio Irigoyen wrote in a report last Friday that historic budget deficits are one reason he believes the Fed cannot cut rates again in the short term. He stated that Trump's proposed policies will only make lowering rates more difficult.
"Trump's Economics 2.0 carries significant uncertainty for the U.S. and the rest of the world," he wrote, adding that "protectionist policies" will fuel expectations of higher inflation, while "excessive fiscal stimulus," including Trump's plan to spend over $5 trillion extending his 2017 tax cuts, will only stoke inflation further.
Another major economic consequence facing the incoming Trump administration from the large deficit is that the rising federal deficit may divert investment away from more efficient private activities to fund government obligations. As the Trump administration seeks to promote investment in energy production and the booming AI sector, the rising deficit could also weaken private spending, as investors buy U.S. Treasury bonds instead of spending money on new ventures.
The Congressional Budget Office estimates that for every dollar increase in the federal deficit, domestic private investment decreases by 33 cents, and the impact of weak private spending could lead to a slowdown in economic and wage growth.
Republicans are aware of this reality, hence their pledge to save trillions through a "Department of Government Efficiency" (DOGE) and cut healthcare programs like Medicare and Medicaid. However, even if these politically painful spending cuts were to materialize, they are unlikely to do much more than cover the costs of Trump's massive tax cut plan. (Note: The Republicans control the House with the narrowest majority in over a century.)
Bank of America's Irigoyen wrote that, at best, Trump and his allies in Congress could only reduce the deficit-to-GDP ratio from the current 6% to 4%. He added that while this would be "significant progress," it remains unclear how much this would alleviate the economic burden caused by high deficits.
"A more reasonable scenario is that deficits in the next two fiscal years will not decrease at all, as tax cuts, interest spending, and increased welfare spending offset the spending cuts and tariffs suggested by DOGE," Irigoyen wrote. "Don’t hold your breath for fiscal consolidation."
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