I first visited Washington more than a half-century ago. As a grade schooler, I was awed by the monuments and the officials hustling around Capitol Hill. I returned home with a deepened respect for how government was handling the nation’s business.
My most recent return to Washington occurred last week. I am much less naïve than I was back then, but aged-based increases in cynicism do not fully account for some of the concern that I have about the way officials are currently handling the nation’s business.
Two long days of meetings with fellow economists, administration officials and political analysts yielded a series of insights related to the pending change of government. A summary of that intelligence follows.
- The fiscal ambition within the Republican platform may be limited by procedure and politics.
In our recent piece on the reconciliation process, we noted that the House will get one opportunity next year to enact major budget initiatives. Extending provisions of the Tax Cuts and Jobs Act (TCJA), appropriations for border security, and other measures have to fit into a framework that does not increase the annual deficit after a ten-year period.
Independent projections suggest that it will not be possible to enact the full fiscal wish list without breaching the rules of reconciliation. A series of puts and takes will be necessary.
A critical element in upcoming calculations will be tariff revenues. Estimates suggest that full implementation of proposed trade measures (levies of 60% on all Chinese products and 20% on imports from all other countries) could raise substantial sums over ten years.
But prospective proceeds from these trade measures will be reduced by a number of factors. Tariffs act as a substantial increase in corporate taxes paid by importers, who will lobby aggressively to limit them. Experts therefore anticipate that peak tariff rates will not be realized, and that new assessments will be phased in over time.
Further, correspondent countries will certainly retaliate. As an example, China hit U.S. agricultural exports with a 25% tariff in 2018, costing American farmers dearly. Observers are expecting similar measures next year, which will almost certainly prompt an increase in U.S. aid to the sector.
Tariffs will have impacts on growth, inflation and interest rates. These dynamic reactions will also serve to diminish the revenue that will accrue to the government.
Finally, there is an active procedural debate over whether all of the actions and reactions surrounding tariffs would be built into the budget baseline. If they are, increased levies on trade cannot be used to “pay for” the cost of making TCJA provisions permanent. The parliamentary maneuvering that will surround the process will have a substantial influence on the shape of the reconciliation bill.
In sum, legislative reach may be well ahead of grasp when it comes to the federal budget.
- The new Department of Government Efficiency (DOGE) has its work cut out for it.
Led by Elon Musk and Vivek Ramaswamy, DOGE aims to reduce government spending by $2 trillion annually. A cut of that magnitude would represent about one-third of yearly federal outlays.
The effort faces a number of obstacles. More than 70% of federal spending is either interest on the national debt or mandated by law. Another 13% is defense spending that is considered discretionary; that is unlikely to be reduced, given the level of geopolitical uncertainty. That doesn’t leave a lot of flexibility.
The size of the federal workforce may be a target for the budget cutters, but the share of government jobs in the U.S. economy has been shrinking. Declines in service levels from staffing reductions will not be popular with the populace. Further, DOGE will need acts of Congress to adopt its recommendations; legislators could push back on service cuts and losses of government jobs in their districts.
Past efforts to streamline government spending have had only modest success. All of them discovered that it is easy to identify potential economies, but it is hard to implement them. At this early stage, it isn’t clear that the efficiency team will make the progress they might hope for before DOGE is sunset in mid-2026.
- The legislative calendar could affect the content of next year’s budget bill.
Congress is in session for less than half of each year. The limitation of time can sometimes limit a legislative agenda. Next year, the House and Senate will have to accommodate confirmation hearings and the crush of new legislation that will be recommended. Fiscal discussions could be protracted, given their complexity. As well, the very thin Republican majority in the incoming House (which has been temporarily reduced by the nomination of three Republican legislators to posts in the new administration), could make it difficult to secure needed votes without offering concessions to members of the caucus.
Expectations of changes in energy policy may be exaggerated.
Campaigning for the midterm election will begin in earnest late next year. During this century, unified governments have not lasted very long, which may add to the pace with which incoming office holders act next year. Both the Affordable Care Act and the Tax Cuts and Jobs Act were passed along purely partisan lines after election sweeps in 2008 and 2016. There may not be enough time on the clock this time around to get the entire wish list passed.
- The change in tone on energy policy will take time to take effect.
The 29th United Nations conference on climate change occurred last week. By all accounts, the mood was less than upbeat. The U.S. election results will not help efforts to contain global warming. The incoming administration has a very different point of view in this area from its predecessor, as evidenced by early Cabinet nominations.
To help pay for tax reductions, Republicans will likely seek to reclaim funds earmarked for energy transition under the Inflation Reduction Act (IRA). But rumors of the Act’s demise may be exaggerated. A majority of the projects financed under the program have benefitted Republican districts, some of which may be close calls in the 2026 elections. I came away from last week’s meetings with the impression that the IRA may not be dismantled summarily.
Increasing American fossil fuel production will be a gradual process. Federal land may be released for exploration, but expanding production will require labor and equipment that may take time to assemble. Limited U.S. refining capacity will present another hurdle.
Output will only increase if it is profitable. OPEC has been restraining its supply for two years in the hope of keeping oil prices high. Facing the combination of falling market share and profit margins, Middle Eastern producers may turn their taps back on, causing prices to fall. That would challenge the economics of new American production and make it more difficult for the sector to attract capital. Falling energy prices could, however, prove to be an offset to the inflationary effects of tariffs and reduced immigration.
Visits to Washington are not as uplifting as they once were for me. But those trips are nonetheless essential to understanding the state of play for policy. Given the current pace of change, I expect to be back in the Beltway frequently in the months ahead.
Information is not intended to be and should not be construed as an offer, solicitation or recommendation with respect to any transaction and should not be treated as legal advice, investment advice or tax advice. Under no circumstances should you rely upon this information as a substitute for obtaining specific legal or tax advice from your own professional legal or tax advisors. Information is subject to change based on market or other conditions and is not intended to influence your investment decisions.
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