Big deficit bill

Residual hopes that the Big Beautiful Bill would put the US budget on a more sustainable trend were dashed by the version passed in the House last week. There are only faint hopes that the Senate will trim the projected deficits. This means another small stimulus in 2026 and then continuing deficits as far as the eye can see. Not surprisingly bond yields are up, especially at the long end, and the term premium has risen.

The Big Beautiful Bill (it’s official name, hereafter BBB) projects spending and taxes over 10 years, standard procedure in US budgeting. The analyst trying to figure out what it means for the next year is always tempted to simply divide by ten. But politicians are cunning. The BBB is carefully crafted so that many of the political goodies such as lower taxes on tips and overtime expire in 2029 (after Trump’s term), while many of the measures to pay for increased spending don’t start until 2029. Front-loading big time.

Hence dividing by 10 doesn’t tell us the effect in 2026. Early estimates suggest that the BBB is mildly expansionary near term, adding perhaps $300bn to the deficit or 1% of GDP. Tariff revenue (not included in the budget since tariffs have not been legislated) would probably cut that by half, perhaps slightly more. So, it is a modest new stimulus, though it is to an economy already at full employment with above-target inflation. It’s not surprising that bond yields have been edging up despite all the uncertainties. Nor that the Fed is nervous.

Meanwhile, if you believe those tax cuts will be allowed to expire in 2029 and the savings measures will actually be implemented, I have a bridge to sell you. Hence the ten-year totals as stated are highly misleading and are likely much higher.

Research from the non-partisan Yale Budget Lab suggests that, as written, the BBB will add $3.4 trillion to debt over the 2025-34 period, but $5 trillion if the tax cuts are made permanent. They reckon current tariffs (before the weekend’s threat of a 50% tariff on the EU) could bring in about $2.5 trillion, (though that estimate is a bit higher than most – obviously we don’t know what the tariffs are going to be yet).

The long-term picture suggests that, after 2026, there will be no new fiscal stimulus but the deficit will remain around 6-7% of GDP. Of course, the actual outcome depends on the pace of economic growth and the level of interest rates.

Kevin Hasset, Chairman of the President’s Council of Economic Advisors, has claimed that GDP growth could accelerate to ‘well north’ of 3% in the next few years. Hardly anyone else believes that, especially given the collapse in net immigration. The Congressional Budget Office projects medium-term growth at 1.8% pa.

Some elements in the BBB could boost economic growth such as easier business expensing – see this Tax Foundation blog for details. But the Tax Foundation reckons these are offset by other elements which are growth-negative. Tariffs are also growth-negative. And if the overall effect is higher interest rates than otherwise, that will be growth-negative too by reducing investment.

The fiscal stimulus of the last few years has been a key factor in delivering strong US GDP growth, high profits and booming stock markets. The BBB gives us one more year of that game. After that, the deficit will stay high, but will no longer provide any net new stimulus. Instead, it will mean a steadily rising debt burden, which points to relatively high interest rates and slow growth.

Perhaps the AI revolution will come to the rescue, boosting GDP growth substantially. If not, the BBB is a missed opportunity. Trump could have followed the 1990’s strategy (championed by George Bush senior and Bill Clinton) of lower deficits, lower interest rates and accelerating GDP. Unfortunately, Trump prefers high spending and large tax cuts. He is not called populist for nothing.