Measuring Trump 2.0’s fiscal room for manoeuvre

The federal government’s 2024 fiscal year1 ended with a government deficit of 1.8 trillion dollars: this represents 6.4% of GDP and an increase of 138 billion dollars over the previous year (6.2% of GDP). From a historical perspective, this is a very high figure. The average deficit over the past 50 years is 3.8% of GDP, and since 1946 it has only exceeded the 2024 level in six years: from 2009 to 2012, during the Great Recession, and from 2020 to 2021, in the years of the pandemic, both being periods of recession with a high unemployment rate. In 2024, however, the average unemployment rate was 4.0% and GDP growth was strong, which makes the current situation more worrying. The outlook is not terribly encouraging either. In fact, the Congressional Budget Office (CBO)2 estimates that the total deficit will continue to fluctuate between 5% and 7% of GDP over the next decade, with federal government debt rising above 120%. To a large extent, these deficits will deteriorate due to an increase in interest payments (the CBO projects a reduction in the primary deficit, which excludes interest payments, from the current 4.0% to 2.7%).3

In this context, we must ask ourselves how the new White House administration’s economic policies will affect the deficit. With few details and little clarity on the measures that will be taken (beyond what was discussed in the campaign, we will have to consider the reality of the negotiations in Congress and their final implementation), it is still too early to estimate the net impact accurately. However, we can conduct a preliminary analysis in order to understand the initial implications.

The federal government has three main sources of revenue: approximately 50% is derived from personal income tax, 35% from social security and Medicare contributions, 11% from corporate taxes, and the remaining 4% includes duties, inheritance taxes and other income. The CBO estimates that, by the end of 2034, revenues will increase to 18% of GDP from the current 17.1%. However, that projection assumes that the tax reductions stipulated in the Tax Cuts and Jobs Acts (TCJA) approved in 2017 will expire in 2025,4 resulting in tax rates reverting to higher rates. However, one of the great bastions of Trump’s campaign was to make the measures under the TCJA permanent. This would add between 3.5 and 5.0 trillion dollars to the deficit5 over the next 10 years, bringing it to around 8% or 9% of GDP (with debt climbing above 130%). If other measures proposed during the campaign are also approved, such as deductions on social security benefits, tips and overtime work and an additional corporate tax rate cut to 15%, estimates point to an extra 3 trillion dollars in deficit.

Alongside this deterioration in the deficit, the main new source of revenue highlighted in the election campaign by the new administration has been tariffs. However, the collection of tariffs falls far short of the projected deterioration of the deficit. For instance, in 2024 the government collected just 80 billion dollars in tariffs, representing 2% of total revenues (in contrast, personal income tax revenues amounted to 530 billion dollars). Even in an extreme case in which a 100% tariff were introduced on all imports of goods from China, the extra revenue would come to 400 billion dollars per year, but only if we assume that the 100% tariff does not cause a fall in import volumes, which is highly improbable: with such high tariffs, it is unlikely that the imports affected could represent a recurring and stable income on which the Treasury would be able to count. Similarly, a universal 10% tariff on all imports of goods could raise between 3 and 4 trillion dollars on a cumulative basis over the next decade, but again this is assuming local demand is inelastic to import prices and that there is no substitution or fall in import volumes. In addition, there is some uncertainty over the purpose of their use: will tariffs be used merely as a negotiating strategy and therefore as a temporary tool, or as a recurring and more permanent source of revenue?

An alternative way to avoid the deterioration of the deficit could be spending cuts. To that end, the president created the DOGE (Department of Government Efficiency), led by Elon Musk, who declared an intention to cut spending by 2 trillion dollars over the next 18 months. Federal spending is divided into three categories. The first is «mandatory» spending (60% of the total), which includes commitments such as social security and health; this is stipulated by current legislation, so changes to laws are required in order to implement cuts. That is, it is difficult to reduce it, both from a legal standpoint and from a welfare perspective (since it mainly includes social security benefits and healthcare). The second category is discretionary spending, which is negotiated each year in Congress and in 2024 amounted to 1.8 trillion dollars.6 However, discretionary spending does not seem easy to cut either (approximately 50% is defence spending) and, in any event, it is at historically low levels and looks set to decline under the CBO’s continuity forecasts. The third type is interest payments on government debt, which is where much of the deterioration is concentrated. In 2024, interest payments increased to 949 billion dollars, which is more than the total spending on defence (826 billion) or Medicare (870 billion) and represents almost 15% of total spending. Interest payments are likely to continue to rise. In fact, in the CBO’s baseline scenario, with an interest rate around 4% and in which the primary deficit is predicted to fall from the current level of 4.0% to 2.7% by 2034, it is estimated that interest payments will increase to 1.7 trillion dollars (4% of GDP vs. 3% today). Stabilising interest spending would require a clearly greater fiscal effort and/or a scenario with significantly lower interest rates: we estimate that it would require either a reduction in the primary deficit of up to 1.5% of GDP in 10 years, or interest rates to converge on their pre-pandemic level of 2%.7 Reducing interest payments would require an even greater fiscal effort or even lower interest rates.

In short, the fiscal scenario in which Trump finds himself at the beginning of his second term is very different from that of 2017 (see first chart). The overview of the current state of the public accounts and of the major fiscal proposals put forward by the new administration during the electoral campaign points to a sustained increase in the deficit and, consequently, in the level of debt. Given this outlook, doubts arise regarding the new administration’s true capacity to implement its fiscal proposals.