On the One Hand, OBBBA; On the Other, Tariffs

Before the 2024 presidential election my uncontroversial view of the near-term economic outlook was that real GP would grow near 2% for the next few years with the economy remaining near full employment, inflation subsiding towards 2%, and the Fed gradually cutting its policy rate. I assumed the personal provisions of the Tax Cuts and Jobs Act (TCJA) would be extended beyond 2025, and that both the limitations on state and local tax (SALT) deductions and the temporary business provisions in TCJA would sunset as scheduled under current law.

Now Congress is debating the One Big Beautiful Bill Act (OBBBA) while courts decide the legality of new tariffs imposed by the Trump Administration. Here I offer thoughts on how, directionally, these policies, if enacted, would shift my view of the near-term outlook for real GDP growth. To organize my discussion, I’ll group the policies like this:
• OBBBA o Extend TCJA o New tax cuts o New tax increases o Increased spending by the Department of Homeland Security o Spending cuts, including Medicaid • New tariffs

Let’s begin by asking how much failure to extend TCJA might undermine near-term growth. I’m skeptical of estimates suggesting the impact to be large but, given limitations here on space, a picture is worth thousands of words. The nearby chart shows annual real GDP growth from 2011 through 2024, including the first two years (2018 and 2019) when TCJA was in effect, but before COVID punctuated the near-term outlook. Then, like today, the economy was near full employment with inflation near the Fed’s 2% target. I don’t see a significant pickup in growth during those two years even though, as its centerpiece, TCJA cut the corporate tax rate to 21% permanently. Perhaps not all ceteris are paribus here, but would I expect failure to extend the other provisions of TCJA to have a big negative impact on near-term growth? No and in any event, as mentioned above, I expected the personal provisions of TCJA to be extended.

To help finance the reduction in the corporate tax rate, TCJA made other business tax cuts temporary and also included subsequent business tax increases. For example, under current law “bonus depreciation,” which has fallen from 100% in 2018 to 30% in 2025, ends next year. Limitations on deductions for interest and depreciation of R&D expenditures were implemented in 2022 and 2024. Here OBBBA would not extend current policy but rather would revive the initial TCJA provisions for five years. It also makes the TCJA treatment of certain foreign earnings permanent. I’d not assumed these “extensions” of the business provisions of TCJA, so I consider them new tax breaks that would boost my forecast.

OBBBA also includes new temporary tax cuts. For individuals, important new provisions are no taxes on overtime pay or tips for five years, and tax breaks for seniors. I consider these a modest stimulus to consumption. For businesses, important new provisions are the expensing of construction spending on manufacturing plants and an expansion of Section 179 expensing of equipment. These, too, are a near-term stimulus. Before seeing the impact on construction of the tax credits that were included in the Inflation Reduction Act (IRA) for the production of chips and batteries, I was skeptical that structures investment responded much to tax incentives. The expensing of structures is not as strong an incentive as a tax credit, but now I’d expect to see a measurable impact on construction in the manufacturing sector, another “plus” for the forecast.

OBBBA rescinds most of the “green” credits and subsidies included in the IRA and limits SALT deductions. I consider these new tax increases. Regarding rescission of IRA provisions. The macro models I’ve worked with are pretty good at sizing the macro impact of changes in federal spending and statutory tax rates, but not so good at evaluating the effects of tightly targeted credits and subsidies. This is partly because the main result of such credits and subsidies is the microeconomic reallocation of resources, not an increase in GDP. Still, I count rescission of credits and subsidies in the IRA as a negative for the near-term outlook.

Under OBBBA the Departments of Defense and Homeland Security (DHS) would receive spending increases, while the Department of Education and the Medicaid program would see bigger decreases. The cuts in Medicaid will result directly in lower consumer spending on healthcare services, a negative for the outlook. Perhaps ironically, increased spending by the DHS, if used to expand a crackdown on immigration and immigrants, would lead to slower economic growth quickly by shrinking the labor force. It’s hard to put a number on this effect, but already growth of the foreign-born workforce is slowing. Press reports suggest the Administration wants to increase daily apprehensions of undocumented immigrants from the recent 1,000 to 3,000. Over two years might reduce the labor force by ¾ million persons.

Finally, tariffs. It is speculative, but I think not unreasonable, to assume in the forecast at least a new 10% tariff on goods. My reasoning is that even if courts disallow the tariffs as emergency measures, the Administration, citing the 1974 trade act, will try to impose tariffs of up to 15% on the half a dozen or so countries with which the US runs the largest trade deficits. This is a huge tax increase. The Congressional Budget Office (CBO) estimates around $200 billion per year through 2034. It is an unambiguous negative for near-term growth, potentially exacerbated if the Fed responds to the resulting inflation impulse by raising interest rates. Furthermore, imports of goods are disproportionately concentrated in capital goods, the prices of which would rise sharply under the tariffs, undermining the new investment incentives included in OBBBA.

Would the stimulus from extended and new tax breaks in OBBBA outweigh the drag from rescinding portions of the IRA, cutting spending, and sharply raising tariffs? A general way to address this question is to consider the net impact of these policies on the deficit based on “scores” published by CBO and the Joint Committee on Taxation (JCT). I’ve summarized these through 2030 in the nearby table. Every year the policies new to my forecast would, on balance, reduce the deficit, a fiscal contraction that would encourage me to shade down my forecast of real GDP growth over the next few years. That’s before including any adverse impact on growth from the Administration’s policies on immigration or considering the deleterious effects of the uncertainty surrounding the Administration’ policy initiatives.

How much would I nudge down my near-term forecast to reflect these policies? Only modestly. In that regard I’m reminded of advice once given to an audience by Rudy Penner, former Director of CBO. When assessing the impact of policy changes on the economy, he said, average your best estimate with zero.

A PDF version of this commentary is available here.