First published on The Next Recession
The US House of Representatives, the lower house of Congress, in which the Republican party has a slender majority, has passed President Donald Trump’s government budget proposals. Trump calls this “The Big, Beautiful Bill”. It would extend sweeping tax cuts for the better-off and rich that were passed in 2017 during Trump’s first presidential term. The beautiful bill would also make big reductions to the Medicaid insurance scheme for low-income individuals and to a food aid programme. And of course, there are cuts in tax subsidies for renewable energy (‘drill baby, drill’).
Trump had called for $163bn in cuts to federal spending. Non-defence spending is to be slashed by 22.6% to its lowest level since 2017, alongside a sharp increase in the defence budget. While non-defence government services are to be drastically cut, government outlays will rise 13% for ‘defence’ and 65% for ‘homeland security’, with the aim to clamp down on so-called ‘illegal immigration’.
The planned cuts in Medicaid are particularly brutal. America is the only advanced economy without a system of universal health coverage. The US spends more than $4.5tn annually on healthcare. Healthcare is the largest component of US consumer spending on services (well above expenditure on recreation, eating out and hotels). Safety net programs like Medicaid lift 45% of Americans who would be below the poverty line out of poverty. Substantial cuts to Medicaid would result in millions without health insurance. And these programs don’t only serve those below the poverty line, but millions more paycheck-to-paycheck, near-poor families.
The tax cuts will primarily benefit high-income households and corporations, while the spending cuts will disproportionately affect low- and middle-income households. These include reductions to Medicaid, nutritional assistance programs, the layoff of hundreds of thousands of federal employees, and the dismantling of entire government agencies.
According to recent estimates by the Yale Budget Lab, the average after-tax-and-transfer income of households in the bottom quintile and second-to-bottom quintile is expected to decrease by 5% and 1.4%, respectively. On the other hand, households in the fourth and top quintile will see their incomes increase by 1.4% and 2.5% respectively. These losses are on top of the estimated reduction in median household income by 2.8% due to Trump’s tariffs. The Center on Budget and Policy Priorities reckons these estimated losses of the bottom quintiles are likely conservative, as they do not account for cuts overseen by the House Education and Workforce Committee, which are expected to affect student loan repayment conditions.
What this tells you is that all the talk of Trump changing America’s previous neo-liberal pro-free market policies towards some ‘industrial strategy’ based on protectionism applies only to international trade. Trump’s domestic policies are neo-liberal on steroids – more for the rich and less for the rest; more spending for the arms industry and less on public services for the rest of us; and more for big business and less for labour and small businesses. Trump’s budget will only increase the already grotesque rise in inequality of wealth and income in the US seen in the last 40 years.
But this is not what worries America’s ruling elite. What is not beautiful but ugly to them is not rising inequality, but the sharp rise in the government budget deficit and overall public sector debt that will follow the implementation of this budget. The non-partisan Committee for a Responsible Federal Budget estimates Trump’s budget would increase the public debt by at least $3.3tn through to the end of 2034. It would also increase the government debt-to-GDP ratio from 100% today to a record 125%. That would exceed the rise to 117% projected over that period under current law. Meanwhile, annual deficits would rise to 6.9% of GDP from about 6.4% in 2024.
Does this matter? After all, the US authorities can borrow more dollars from the banks and financial institutions by issuing government bonds. But the government must pay interest on those extra bonds for a decade or more ahead. And can the US government under Trump be trusted to control spending and meet its obligations? Moody’s, the largest US credit agency that monitors the likelihood of default on debts by companies, is not so sure as it was. It announced a downgrade in the credit-worthiness of US government debt. As a result, almost immediately, the interest demanded by financial institutions on buying US government debt rose. The 30-year Treasury yield rose to a peak of 5.04%, its highest level since 2023. That will add to the cost of interest on the government’s debt. According to Moody’s, interest payments in the US are on a path to consume 30% of the federal government’s revenue by 2035, compared with 9% in 2021. But most important, this will also feed through to the interest charged on all borrowing by companies and household mortgages. If businesses can’t get access to credit, that can halt investment and lead to job losses over time. First-time buyers and those wishing to move home could also face higher costs.
Trump’s MAGA advisers say the budget will pay for itself with higher growth from tax cuts and deregulation. This is the classic ‘trickle down’ theory that tax cuts for the rich will boost economic growth, continually claimed by free market economists and refuted time and again as effective. The MAGA boys and girls argue that revenues from the tariff increases proposed on foreign imports will compensate for the loss of revenue from the proposed tax cuts. This, of course, is nonsense. The Congressional Budget Office (CBO) reckons that Trump’s tariff increases will collect $245bn more in tax revenues than in fiscal year 2024. But that is a tiny sum against the $5.2tn in total tax receipts that the CBO expects this year and the $1.8trn budget deficit.
The Maga advisers in the Trump administration want the Federal Reserve to deregulate the financial sector to remove restrictions on the leverage ratio (ie asset buying limits) on banks so that they can buy more US treasuries. It seems that the lesson of the March 2023 banking crisis is to be ignored. That’s when some regional banks went bust because they held too many US government bonds that suddenly dropped in value.
Some have even suggested that Trump’s fiscal largesse will actually lead to a financial crisis – just as it did for Liz Truss in the UK. Truss was (very briefly, just 47 days) UK prime minister in the Conservative government in 2022. She introduced a ‘budget for growth’ which slashed taxes for the rich in true ‘trickle-down’ mode. The projected rise in the UK budget deficit and public debt so frightened holders of UK bonds, particularly pension funds that held a huge share, that the value of UK ‘gilts’ plummeted and the Bank of England was forced to intervene and buy bonds to stop interest rates spiralling out of control. Also, the UK pound slumped to its lowest level ever in FX markets. Within weeks, Truss was removed as leader by her party, under pressure from the financial institutions that bankrolled the Conservatives, and former hedge fund manager and Goldman Sachs executive Rishi Sunak took over. The markets ruled.
Liz Truss with her MAGA cap for the Trump inauguration
Still, a ‘Liz Truss moment’ is not going to happen in the US. The UK runs twin trade and budget deficits like the US, but it depends much more on what current Canadian PM and former Bank of England governor, Mark Carney, called ‘the kindness of strangers’. In other words, the deficits must be financed by foreign investment, either investment in UK industry or in its bonds and currency. That ‘kindness’ disappeared overnight under Truss. But that won’t happen under Trump because the US dollar is the world’s reserve currency and main trading and investment currency and will remain so. It’s true that the dollar has slipped in recent months under Trump following his tariff war and after his budget plans. But it is still at relative highs historically.
The real issue is not the trade and government deficits or the swings and turns of Trump’s tariff war – the latest being the decision to impose a 50% tariff on all imports from Europe next week unless there is a trade deal. Financial markets and investment bank economists yo yo up and down with each Trump tantrum, because they are not sure if the ‘Taco’ factor is operating – namely the notion that Trump Always Chickens Out on his threats in the end. No, the real issue is whether the US economy is heading towards a recession ie an outright decline in national output and investment and a significant rise in unemployment; or alternatively ‘stagflation’ where the economy stands still in output and income terms, but inflation and interest rates stay high.
In the first quarter of 2025, US GDP fell 0.3% on the first estimate – that may be revised upwards in the next estimate. And if you strip out exports and imports and government spending, the domestic private sector is still growing modestly. But the US economy is standing on a precipice, with Trump’s tariffs, which remain in place at some 15% higher on average than before, ready to knock it over the cliff.
One highly used indicator of recession is the so-called Sahm measure. The statistic, named after former Federal Reserve economist Claudia Sahm, compares the most recent three-month average unemployment rate with the minimum three-month average over the previous year. If the difference is greater than 0.5% pt, then a recession has started. The Sahm measure currently sits at close to 0.3% pt and would require monthly unemployment rate increases of 0.1 percentage points until September 2025 to reach the threshold. So on this indicator, the US economy is not in a recession and even another quarter of negative growth is unlikely to generate one.
But for me, unemployment is a lagging indicator for the economy. A Marxist theory of crises starts with profits, goes on to investment, and then to income and employment. So the key leading indicator will be profits. For now, corporate profits are still rising, if at a slowing pace. But if profits start falling, it won’t be too long after before investment in the productive sectors of the economy (industry, information, transport, fossil fuel production etc) start to fall. That will signal the beginning of an outright slump.
US corporations are now facing slowing demand for their goods and services, particularly for exports, and tariffs will drive up production costs that firms will have to absorb by reducing profits or laying off workers or that they will pass onto households in higher prices – or both. Add in rising and relatively high interest rates on new borrowing and on servicing existing debt and the profits squeeze will intensify. Citibank reckons that average corporate earnings growth will drop to just 1% this year. And a recent Fed study found that a “sudden stop” on Chinese imports would affect 7% of US corporate investment.
Moreover, companies that have made profits in the last year are not re-investing into new capacity, but instead buying back their own shares to boost their share prices (to the tune of $500bn over the past three months).
American households are also not as confident about the economy as the Maga advisers or the investment bank economists. Consumer confidence has dropped to the second-lowest level on record.
And that’s not surprising when the gap between what Americans earn and how much they need to bring in to achieve a decent standard of living is growing. According to the Ludwig Institute for Shared Economic Prosperity (LISEP), for the bottom 60% of US households by incomes, a “minimal quality of life” is out of reach. The US official unemployment rate of 4.2% greatly understates the level of economic distress. LISEP factor-in workers who are stuck in poverty-wage jobs and people who are unable to find full-time employment, and that takes the US jobless rate to over 24%. Those lowest earning American households, which in 2023 earned an average of just $38,000 per year, would need to make $67,000 to afford what a household needs to have a decent life. Housing and health care costs have surged, while the amount of savings required to attend an in-state, public university has soared 122%. Meanwhile, median earnings for the bottom 60% of income earners have fallen 4% between 2001 and 2023.
And now they are to receive Trump’s ‘big, beautiful’ tax bill.