Economics Update March 2025 - Trump's economic policy: there is no ‘free lunch’

At the start of his second term in office, President Trump demonstrated his drive and willingness to implement his agenda to his supporters in particular with a flood of decrees. However, he cannot simply enact one of his most important projects single-handedly: Trump needs the approval of Congress for further tax cuts. This is likely to be tied to a simultaneous reduction in the high budget deficit of around 6% of economic output.

The project is tantamount to squaring the circle. It will be interesting to see how it is to be achieved. The starting position: government revenue amounts to 4.9 trillion dollars, while expenditure is 6.7 trillion dollars - a deficit of 1.8 trillion dollars.

Revenue could be increased by up to 200 billion dollars through tariffs if the average tariff rate on US imports is raised to 10 percent. Before Trump's first term in office, this rate was below 2 percent, rising to around 3 percent by 2020. With the tariffs now announced of 25 percent on steel and aluminum imports and 10 percent on all imports from China, the average tariff rate would rise to around 4 percent. If the Trump administration actually wants to implement an average tariff rate of 10 percent in order to generate revenue, we can expect a lot more tariffs. In the USA itself, this would not be without consequences for inflation - and this does not even take into account countermeasures by the countries affected.

Savings potential not easy to find

On the expenditure side, around 2.3 trillion dollars for interest payments and social security are fixed, while a further 1.5 trillion dollars for Medicare and Medicaid are also not to be touched according to current plans. This leaves three spending blocks that could be cut: Firstly, there is 1.1 trillion dollars that could be cut as part of a so-called budget reconciliation - an adjustment to long-term budget planning - with a Republican majority. Secondly, the USA spends almost 900 billion dollars on defense - whether and to what extent there will be savings here is unclear. Thirdly, there is just over 900 billion dollars in discretionary spending - this block is currently at the center of the activities of Elon Musk and his Department of Government Efficiency (DOGE). According to estimates, the furor Musk has shown so far would only result in savings of around 2.6 billion dollars. That would be a tiny fraction of the sum in question. Larger savings programs require a majority of 60 votes in the Senate. This means that not only all Republican senators would have to agree, but also some Democratic ones. While the former is probably quite unlikely, the latter can almost be ruled out.

The decision-making process is likely to take many months and involve considerable dispute within the Republican Party, which is not good news due to the uncertainties involved. The likely outcome could be that the tax cuts from Trump's first term in office remain in place, but that there are no further tax cuts and significant cuts are made on the spending side. This would make fiscal policy noticeably more restrictive than before. However, expansionary fiscal policy has been a key driver of the US economy to date.

Robust growth or sound public finances: An unpleasant choice

The end result could be an unpleasant choice: Either the Republicans decide to prioritize fiscal consolidation and accept a significant slowdown in what has been robust growth, or Trump follows through with his tax cut plans without regard for government finances, risking a sharp rise in long-term interest rates as investors demand higher risk premiums for US government bonds. Either way, we are likely to face turbulent times ahead - time to think about greater global diversification of investments and critically question any dependence on US assets.