Tax Reform vs Tariffs: Trump's Policy of "Mutual Struggle"

The rapid changes in the outlook for U.S. economic growth can be summarized as a story of two tax policies.

According to Zhitong Finance APP, U.S. President Donald Trump and his aides, along with Republican lawmakers, insist that the comprehensive tax bill being pushed through Congress will stimulate investment and consumption, ushering in a new golden age for the U.S. economy. Private sector economists generally agree that this bill, which extends the income tax cuts from 2017 and introduces new incentives, will indeed boost the economy.

However, the problem lies in Trump's simultaneous imposition of tariffs on imported goods. This is likely to erode household purchasing power and suppress economic expansion. While the government claims that the newly erected tariff barriers will encourage manufacturing to return to the U.S. and drive job growth, most economists are skeptical. Surveys also indicate that the uncertainty surrounding the final tariff rates may suppress investment at least in the short term.

The combined impact of these two policies on economic growth in the coming years has become a hot topic among economists.

David Sewell, an economist at Nomura Securities for developed markets, stated, "We believe the impact of tariffs on growth will far exceed the stimulative effect of the tax reform bill." The investment bank has lowered its forecast for U.S. year-end growth to 0.8%, well below the potential growth rate of about 2%.

The latest median economist forecasts compiled by Bloomberg indicate that U.S. GDP growth is expected to be 1.4% this year, 1.5% in 2026, and 2% in 2027. In contrast, since the pandemic shock in 2020, the annual growth rate in the U.S. has never fallen below 2.5%.

Despite Trump's talk of a "golden age," economists still believe U.S. economic growth will slow.

As Republican lawmakers push for a vote on the tax reform bill in the House this week, the government paints a more optimistic picture. Treasury Secretary Mnuchin stated that the growth rate could "approach 3% within a year." The Council of Economic Advisers estimates that the tax cuts will lead to a 4.2% to 5.2% increase in inflation-adjusted GDP in the short term (defined as four years).

Stephen Moore, chairman of the Council of Economic Advisers, emphasized in an interview on Tuesday, "This bill, along with deregulation and the trade agreements we are negotiating, will drive stronger growth."

Natasha Sarin, director of the Yale Budget Lab, pointed out that the White House's assessment is an order of magnitude higher than the predictions of independent analytical agencies. The scholar, who previously served in the Treasury Department under the Biden administration, stated, "Our models show that the positive impact on GDP in the short term will be much smaller."

Discussions on the details of the tax reform are still ongoing within the Republican Party, with Trump personally pressuring lawmakers on Capitol Hill to resolve differences. While there is consensus on permanently extending the 2017 income tax rate cuts and eliminating taxes on tips and overtime income, disagreements remain over expanding state and local tax deductions and the scale of Medicaid cuts.

Tariff Fog

The greater uncertainty lies in the final tariff rates. Trump's so-called "liberation day" reciprocal tariff plan has been postponed due to government trade negotiations with multiple countries, but several tariffs, including a 10% global benchmark surtax, have already taken effect. UBS economists estimated last week that the weighted average tariff rate has risen from 2.5% at the beginning of the year to about 15%The UBS team led by Jonathan Pingle calculated that this amounts to implementing a tax increase of 1% to 1.5% of GDP.

Goldman Sachs Chief U.S. Political Economist Alec Phillips estimates that import tariffs will completely offset the stimulative effect of tax reform on economic growth over the next two years. In a recent client report, he wrote, "Just as the increase in tariff revenue will fully cover the deficit increase caused by the House's fiscal plan, the drag on growth from tariffs will also completely offset the boost provided by the fiscal plan."

Gloomy Sentiment

Current economic data shows a robust labor market, with limited transmission effects from tariffs. However, this situation may change as the effects of pre-tariff rush orders and inventory hoarding dissipate.

Consumer confidence has fallen to the second-lowest level on record, and inflation expectations have reached decades-high levels. The Philadelphia Fed's quarterly survey indicates that the group of consumers facing economic pressure is expanding.

Christophe Hodge, Chief U.S. Economist at French Foreign Trade Bank, pointed out, "For households with tight budgets, the hundreds of dollars saved from tax reform can easily be swallowed up by rising prices at checkout," adding, "The higher prices of goods due to tariffs will inevitably have a substantial impact."