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For
once, the deficit hawks are right. The tax cuts for the wealthy in the
Republican budget could cause the third economic meltdown this century.
Unlike the Financial Crisis and the pandemic, we couldn’t spend our way
out.
by Robert J. Shapiro
President
Donald Trump is charting a course that may end in the economy’s third
meltdown in less than 20 years. Whatever he and his economic courtiers
think they’re doing, the waves of unprecedented budget deficits now under his One Big Beautiful Bill Act and his tariff war could trigger a grave economic crisis that will recall the Financial Crisis and the pandemic.
Whether
budget deficits matter and how much they matter have been political
issues since the government began regularly operating in the red half a
century ago. But deficit hawks cried wolf so often while the United
States economy outperformed other advanced countries that most people no
longer pay serious attention to the deficit. Liberal advocates of the
free-lunch approach to government spending and revenues latched on to
“Modern Monetary Theory,” a set of baseless claims that deficits never
matter because the government can always print the money to cover them.
The president and his cowering congressional Republicans have embraced
the same Panglossian view to defend their tax cuts and soaring spending
for defense and deportations.
The
economics of public finance is indifferent to the expedient rationales
of both sides. Deficits always have effects. They’re a key weapon for
reviving the economy when it’s underwater. They also matter in normal
times because market economies run on credit, and since the government
can’t go out of business, it’s always first in line for available
credit. So, when companies need loans to purchase technologies and other
equipment, build factories, or conduct research and development, and
when people need loans for a house, an automobile, or winter jackets for
the kids, they compete for the credit left over after the Treasury is
done borrowing.
Deficits
matter in normal times like today, depending on their size as a share
of the economy and the funds available. Together, these factors largely
determine the interest rates that the Treasury, private companies, and
American consumers must pay for credit.
That now poses a serious dilemma for the economy. The Congressional Budget Office (CBO) analyzed Trump’s program as enacted. It calculated that the budget deficit will exceed $2.3 trillion or 7 percent of GDP next year and every year for the next decade.
Lower taxes for wealthy households and profitable companies will be responsible for most of the tsunami of red ink. CBO reports that
over the next five years, from 2026 to 2030, Trump’s One Big Beautiful
Act will reduce federal taxes on high-income Americans by an average of
$504 billion annually and federal taxes on businesses by $130 billion
annually. The sweeping law passed without any Democratic votes also
harms millions of Americans by cutting Medicaid and ACA funding by an
average of $93 billion annually and reducing clean energy subsidies by
an average of $45 billion annually. Even so, those painful cuts will
offset less than 22 percent of the reduced revenues from people and
businesses at the top.
The
result of all this Republican borrowing matters greatly, because a
deficit of 7 percent of GDP represents 90 percent of all annual private
savings. From 2022 to 2024, those savings averaged 7.7 percent of GDP—4.1 percent of GDP in personal savings by Americans, and 3.7 percent of GDP in
retained earnings by businesses. On the path set by Trump and
ever-compliant congressional Republicans, financing the coming deficits
by ourselves would require, in effect, that everyone invest 90 percent
of their yearly savings for retirement, college tuitions, or home
downpayments and 90 percent of undistributed business earnings in new
Treasury securities.
Fortunately,
foreign governments and investors have, for several decades, used some
of their savings to buy our Treasury securities, stocks, and corporate
debt. At last count, they now hold $9.6
trillion or 33 percent of all publicly-held U.S. government debt, $4.5
trillion or 32 percent of all U.S. corporate debt, and $16.9 trillion or
27 percent of U.S. stocks. When Trump and his America First fans blame
other nations for “ripping off” the United States, they don’t mention
(and probably don’t know) how much their incomes and lifestyles depend
on foreign loans and investments.
The
outsized deficits coming under Trump’s program will strain those
foreign creditors. Our budget deficits were larger during and
immediately following the Financial Crisis and the pandemic, but those
spikes were anomalies that receded quickly as the economy recovered. In
normal times like today, federal red ink has
represented a fraction of what we now face, with deficits averaging 2.1
percent of GDP in the 1990s, 1.5 percent of GDP from 2000 to 2007, and
3.8 percent of GDP from 2012 to 2019.
During
the financial crisis and the pandemic, the Federal Reserve also kept
the cost of public and private borrowing low. At the same time the
deficits surged, the Fed pumped waves of new credit into the financial
system through unprecedented purchases of trillions of dollars in
Treasury securities and corporate bonds. These “quantitative easing” policies
were Hail Mary passes that broadly succeeded because the economy was so
depressed that inflation remained low despite the extraordinary levels
of fiscal and monetary stimulus.
Trump’s
impending avalanche of new federal borrowing is not an emergency
response to the economy breaking down. Since mid-2022, the Fed has been
selling off the loans it purchased under quantitative easing. Trump’s
program will exacerbate post-pandemic deficits that have averaged nearly
6 percent from 2022 to 2025. The hunt for the trillions of dollars in
savings needed to finance the coming deficits and support business
investment, mortgages, and consumer borrowing will inevitably push up
interest rates.
That’s
one reason Trump regularly attacks the Federal Reserve and his
appointed chair, Jerome Powell, for not cutting interest rates. But
acceding to Trump’s demands in this environment won’t produce the
effects he expects. The Fed directly controls only one interest rate,
the “federal funds rate” for overnight loans between banks. It’s likely
that when the market faces trillions of dollars in new annual deficit
financings, continuing demand for business and consumer credit, and
rising inflation, interest rates will increase even if the federal funds
rate falls. The resulting slowdown or possible recession will further
increase the deficit.
American
economic stability in 2026 and onward depends on the willingness of
foreign investors and governments to lend us more, year after year, than
they ever have before. Their willingness to purchase one-third of our
public debt and nearly one-third of our economy has rested on their
confidence that the U.S. will remain highly productive, innovative, and
stable.
Their
confidence will be sorely tested by MAGA running up trillions of
dollars in new, annual public debt caused by shrinking tax revenue from
the wealthy and corporations and by imposing punishing tariffs on
imports from the creditors we need. If they lose patience and reduce
their purchases of U.S. Treasury securities—or worse, sell holdings—our
interest rates will spike, the stock and bond markets will plummet, and
the economy could crash. And this time, more deficit stimulus won’t
work, and flooding the system with waves of additional credit won’t work.
Trump
is playing chicken with the countries the United States needs to keep
its economy going. For once, the deficit hawks are right.
Robert J. Shapiro, a Washington Monthly
contributing writer, is the chairman of Sonecon and a Senior Fellow at
the McDonough School of Business at Georgetown University. He previously
served as Under Secretary of Commerce for Economic Affairs under Bill
Clinton and advised senior members of the Obama administration on
economic policy. |