President Trump’s second term begins with a series of fiscal hurdles that will shape the trajectory of the US economy. These include avoiding a government shutdown, preventing a default on US sovereign debt and extending his 2017 tax cuts – each connected to managing America’s ballooning national debt. Failure to adequately deal with any of these issues could have enduring political and economic consequences.
Trump inherits a strong economy, with the US pandemic recovery outpacing that of other advanced economies across inflation, productivity and growth measures. But beneath this surface lies a troubling fiscal reality. At over $36 trillion – over six times its 2001 level – the national debt is on an unsustainable trajectory, with the debt-to-GDP ratio poised to hit record heights under Trump’s second term.
But borrowing is not necessarily bad. Throughout US history, it has enabled pressing government action, especially during downturns. Debt-financed spending on areas like infrastructure, research and human capital can boost growth and ultimately pay for itself. However, the current path raises serious concerns. Although stimulus measures helped cushion the economic effects of the financial and COVID-19 crises, other borrowing – for wars in Iraq and Afghanistan and tax cuts for the wealthy – have yielded worse outcomes. Such choices have also driven growing interest payments that now exceed defence spending. Demographic trends and Trump’s immigration crackdowns promise to add further budgetary strain.
The Trump administration’s policy changes could augment or relieve these pressures, although proposed solutions appear inadequate. The nascent Department of Government Efficiency (DOGE) is targeting $2 trillion in cuts – exceeding total annual discretionary spending – but fiscal experts doubt it can achieve even a fraction of those savings.
On the revenue side, President Trump has touted an ‘External Revenue Service’ to collect tariffs from abroad – although American buyers will ultimately bear their cost. Regardless, estimated tariff revenues fall far short of the more than $4 trillion it will cost to extend Trump’s expiring 2017 tax cuts, which would also fuel inflation and exaggerate inequality.
Republican fault lines could complicate action and create opportunities for Democrats
Getting the promised tax bill to the president’s desk, in tandem with funding the government and addressing the debt limit, could prove difficult. There are three significant fault lines within the Republican caucus. One, whether to fund tax cuts with commensurate spending cuts, including to popular programmes, which could cause friction. Two, how to address the debt limit, an artificial ceiling that government borrowing has already reached. Three, whether to lift the cap on the state and local tax deduction (SALT), which allows taxpayers from high-tax states to reduce their federal liability.
Different Republican factions have declared red lines on each issue. With slim congressional margins, Republicans will either need to convince colleagues to back measures they have never before supported – especially defusing the financial and political time bomb of the debt limit – or court Democratic support.
These choices point to deeper ideological conflicts in the difficulties of balancing populist campaign promises with pro-corporate affinities and deficit-busting tax cuts with the remnants of fiscal conservatism. There is little room for error and Republicans are already behind. Congress has failed to move forward decisively without Trump’s direction or blessing, reflecting the concentration of power with Trump himself. But even Trump cannot fully control the caucus, as demonstrated by demands from competing factions and defiance on recent legislation.
The obstacles to legitimate compromise could push Republican leadership to bend the rules or bypass institutional actors. Overriding or firing the senate parliamentarian, rejecting Congressional Budget Office cost assessments or manipulating budget rules to mask tax cut costs would signal their willingness to discard institutional norms to enact Trump’s agenda.
This situation creates opportunities for Democrats – if they can remain united. Republican fissures, especially over the debt limit, create welcome leverage for Democratic lawmakers previously forced to the negotiating table to defuse Republican default threats. While some Democrats seek policy concessions in exchange for a debt limit increase, others argue for its permanent elimination, removing a perennial, unnecessary source of economic risk. Whichever path Democrats take, they must avoid the same reckless brinksmanship they opposed for years. Putting the full faith and credit of the US in question has lasting corrosive effects, even absent a default.
More broadly, there is an opening for Democrats to take the political high ground on the national debt. Roughly half of Americans say they worry a great deal about federal spending and the deficit. And fiscal questions are closely linked to pocketbook issues. Despite Federal Reserve rate cuts, spikes in Treasury yields have pushed up monthly bills – on homes, cars and credit cards – for millions. As expanded borrowing, policy uncertainty and inflation fears weigh on debt markets, Americans may encounter steeper borrowing costs.
Given the number of billionaires in the Trump administration, it would be sensible for Democrats to embrace a populist tone – but they need not surrender on fiscal responsibility. Pitching loophole closures and rate raises for corporations and wealthy individuals can serve both populist and fiscal ends.
Economic and strategic risks
As fiscal decisions reverberate well beyond politics, there are economic and strategic risks. US Treasury markets are the world’s deepest and most liquid, and the likelihood of imminent crisis is low. But there is reason for concern, especially as the US government rolls over some $9 trillion of debt this year, and the composition of Treasury buyers shifts to more price-sensitive buyers like US mutual funds and households (including hedge funds).
