Fantastical Fiscal Speculation

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Stocks may be up nicely from this correction’s low-to-date on April 8, but that hasn’t stopped the traditional correction fear morph. As often happens, the correction’s central story—tariffs—has worn a few guises as investors have chewed over all the potential implications. It is happening again lately as tariff fears morph into US debt fears, courtesy of many outlets warning tariffs won’t raise enough revenue to offset President Donald Trump’s proposed tax cuts. The Institute of International Finance (IIF) was the latest to weigh in, projecting US debt will soar to 130% of GDP by 2034. But don’t pencil in a debt crisis just yet. This forecast is sheer speculation, built more on assumptions and biases than probabilities.

The IIF’s projection is one of many warning of doom as Congress debates whether and how to extend 2017’s Tax Cuts and Jobs Act (TCJA), whose tax provisions expire at yearend. It presumes Congress extends all of those while Uncle Sam earns more tariff revenue from the 10% blanket tariff … but not enough to offset another decade of consolidated tax brackets. But this is just one of many possibilities. Congress is also weighing whether to end the cap on state and local tax (SALT) deductions. Trump is lobbying to make tips, overtime pay and Social Security benefits income tax-free. And lawmakers are nowhere near united on how to amend spending to enable making any tax cuts permanent rather than just extending them for a decade.

Which is to say, at this point, any fiscal forecast is sheer guesswork. There is no way to know, now, what (if anything) Congress will pass. Congresspeople in high-income districts say raising the SALT cap is a must, while fiscal hardliners call it a nonstarter. Some want more spending cuts than their peers are willing to greenlight. Some are drawing red lines around the deficit, others around even the scent of entitlement reform, following a Congressional Budget Office report claiming tax cut math works only if Medicaid, Medicare or the Children’s Health Insurance Program get cuts. And Trump’s proposals from the campaign draw their own variety of reactions. None of these divisions are new. This is how the sausage always gets made. But the more division there is, the more tax plans tend to get sanded down. We haven’t seen any forecasts accounting for this simple political reality.

There is one aspect of the IIF’s forecast we think is on point: its offhand observation that tariff revenue could miss expectations if tariffs rise and the world retaliates, discouraging trade. As a general rule, the more you tax something, the less you get of it. Businesses and consumers to date have been sort of willing to deal with the 10% blanket tariffs, but the higher reciprocal rates—should they take effect in July—are a different beast. The higher the rate, the more incentive there is to avoid it, either routing trade through lower-tariffed domains or just ending supplier relationships in high-tariff nations. That 145% tariff rate on Chinese goods is effectively an embargo. You can’t tax commerce that doesn’t happen … and this doesn’t even get into the astronomical difficulty of enforcing and collecting on all these tariffs, which we covered late last month. So no, we don’t think tariffs are an offset.

But there is also a broader philosophical error in all these forecasts: the presumption that so-called “unfunded tax cuts” must add to deficits and debt. Meaning, that tax cuts without corresponding spending cuts—tax cuts that aren’t somehow paid for by other budgetary adjustments—will make debt balloon. This is the same myth that caused former UK Prime Minister Liz Truss to prematurely change careers two and a half years ago. And the same one that once caused former President George H.W. Bush to whisper spookily about “voodoo economics” when campaigning against Ronald Reagan in 1980.

Yet governments have used “unfunded tax cuts” to spur economic activity for decades. The logic here is the inverse of our tariff logic. While you get less of things you tax more, you get more of things you tax less. There are many examples of tax revenue rising after tax rate cuts for the simple reason that there were more transactions—more economic activity—to tax. The TCJA is a prime example. Its tax cuts, too, were “unfunded,” yet revenue rose in 2018 and 2019. It fell in 2020 as COVID lockdowns halted taxable commerce but soared in 2021 as the country reopened. (It also soared in 2022 as inflation bit society hard, which is unpleasant but true). The result is that, since 2021, federal revenue has blown away the CBO’s first post-TCJA projections by a country mile.

Exhibit 1: The CBO Was Wrong About Unfunded Tax Cuts

Source: St. Louis Federal Reserve and Congressional Budget Office, as of 5/6/2025. All revenues are for fiscal years, and the projections come from the CBO’s April 2018 report.

Once upon a time, people called this kind of tax cut “stimulus.” It is passé, now, as it has become fashionable to discredit economic policies that bore fruit throughout the 1980s and 1990s. (This is not to say swift growth in those periods was all about tax policy—that is an oversimplification. They were likely a boost.) Which, from a market standpoint, is fine and maybe even kind of bullish. Congress’s extending the TCJA, if the current zeitgeist is any indication, could well spark more fear (of debt) than cheer (of faster growth than the alternative), preserving the wall of worry and positive surprise power. That will depend on sentiment’s evolution, but it is a possible outcome.

In the meantime, regarding debt fears specifically, our advice remains constant: Trust the market. Long-term Treasury yields remain down from mid-January’s highs. They are volatile, yes, but not spiking, even as debt and deficit fears mount. And though higher than the abnormally low rates of the 2010s, they are at levels associated with a benign fiscal backdrop throughout 20^th century history. If tax cuts were truly a deficit problem, the market would tell us. It isn’t so far.