Trump’s big beautiful bill is primarily big

Moody’s downgraded US Treasury debt from its top rating, making it the last major agency to do so. The downgrade has been in the works since November 2023, when the agency lowerd the US rating outlook to negative. Formally the downgrade is due to a buildup of the US deficit and the likelihood of more issuance ahead. These are all well-known factors, but the timing is interesting, coinciding with House debates over Trump’s Big Beautifull bill which is likely to raise the deficit further. Adding further fuel to the fire, Moody’s rationalizes their stable outlook based on 1) the role of the US dollar as global reserve currency, 2) effective monetary policy led by an independent federal reserve and 3) the constitutional separation of powers among the three branches of government. All three elements are being put in question by the Trump administration.

The downgrade is unlikely to make a big difference.

Treasury secretary Bessent noted that the credit rating is backward looking and to some extent it is. The US deficit has steadily increased over the past years, under both Democrat and Republican administrations. Yields responded, but ultimately the impact on the fiscal trajectory is limited, and fiscal policy is unlikely to be affected by the current downgrade, even if it is being used in debates regarding the new tax bill.

Trump’s big, beautiful bill substantially worsens the fiscal outlook.

The current deficit is running around $2 trillion a year, over 6% of GDP. The federal debt held by the public currently stands at around 100%, its highest since the Second World War, and it is set to rise to 117% in ten years, even with current law. The bill currently being debated in Congress takes a poor trajectory and makes it worse, pushing the 2034 debt-to-GDP ratio to 125% as written, and 129% if the plans are made permanent. These assume a best case scenario with full employment throught the next decade, and a 10 year government yield that steadily declines. Worse outcomes push the trajectory further up, as higher rates push interest rate payments and deficits higher, lower growth deflates existing debt less, and weaker economic times increase fiscal spending.

The package is made to look cheap by shifting the baseline.

The most important part of the package is an extension of the 2017 Tax Cuts and Jobs Act (TCJA). The Committee for a Responsible Federal Budget estimates that the bill will cost roughly $3.3 trillion over the next decade, $5.2 trillion if the package is made permanent. The bill is made to look cheap by means of deceptive accounting. The TCJA provisions were supposed to expire at the end of this year, having previously been introduced as temporary to keep the costs manageable. Now, they are trying to extend them under a ‘current-policy baseline’ as opposed to a ‘current-law baseline,’ such that the cost of making these permanent is zero, even though it’s a massive extra commitment. This sets precedent to make many 'temporary' measures permenant, such as the long list of campaign promises that are included in the bill on a ‘strictly temporary’ basis. These include, but are not limited to, a tax exemption for tips (confided to jobs that ‘traditionally’ receive such payments) and overtime pay. There is also tax relief for auto loans, as long as the car’s final assembly is in the US.

Debates in Congress are about pulling forward spending cuts, hardly about reducing increased spending.

The bill also includes spending cuts of about $2 trillion (over 10 years), which are mainly focused on cutting subsidies for green energy and lowering federal support for states’ Medicaid programs. Debates and demands over the weekend have mainly focused on pulling these spending cuts forward, rather than discussing the increase in outlays or decrease in revenues. It seems likely that the basic bill, and in particular the TCJA extension will ultimately be passed, leaving a greater deficit and higher government debt in its wake.

How can the US solve its debt problems?

The most elementary option of balancing the budget seems unlikely for current and future administrations. Default is unlikely and unnecessary. Rather, if the Trump administration will attempt to deal with the debt level rather than leaving it for future adminstrations, it is likely to be attempted through one of two ways:

• Increase demand for Treasuries. The first is to increase demand for Treasuries. An example of this is the suggestion that the administration will loosen bank capital rules, and boost demand for Treasuries via changes to the Supplementary Leverage Ratio (SLR) regulation. In a more extreme example, the Miran plan suggested using the US’ leverage to force other countries to hold (long-dated) debt, or worse, convert existing debt. Japan, which has much higher debt, tried this demand strategy in the late 1990s and early 2000s, by changing policy to encourage domestic demand of banks, pension funds and the public to hold debt. It limited yields on Japanese debt, but left a lot of capital tied up in government debt that could be allocated more effectively to more profitable ventures. These efforts would have to be significantly widened in scope for their impact on demand to be measurable. In addition, a key difference is that Japan has had a large and growing pool of domestic savings.

• Inflate your way out of it. By running higher inflation, the real burden of existing debt is reduced. While not an explicitly stated policy goal, both the tariffs and attempts at nudging the Fed to lower rates increase inflation. Tariff policy improves the debt picture in two ways; revenues (although marginal) lower the nominal debt, and the resulting inflation lowers the real debt. However, they also dampen growth, such that the debt-to-GDP ratio might still deteriorate. The repeated calls on the Federal Reserve to lower interest rates will of course also be inflationary, although they’re unlikely to happen with an independent Fed. A renewed round of QE to counteract higher rates due to higher debt levels is equally unlikely at large scale with an independent Fed. Historically, we’ve seen inflation management relieve debt in Europe after the world wars. We’re not likely to see such hyperinflation in the US in the near term, but a repeat of the recent inflationary episode seems less far-fetched.

Lacking the will to balance the budget, the Trump administration’ ability to decrease the debt burden through the two methods above at least partly depends on the three worries of the Moody’s report, and repeated at the beginning of this note. While they might reduce the real burden of debt, they also represent a turn for the worse for the US and its economy. Moreover, the policy comes at a time where markets are already starting to doubt the US’s fundamentals. This might not be the best time for unfunded tax cuts. In contrast to tariffs by executive order, a bill like this cannot be easily reversed. At the same time, the impact is also less sudden and dramatic, leaving more scope for this to play out over a longer period of time. The fiscal largesse points to upside risks to US long-term interest rates, which could eventually prove to be a headwind for both the economy and financial markets.