Why don't we fix the fiscal deficit? That will start fixing our trade deficit

Chief Economist Eugenio J. Alemán discusses current economic conditions.

Let’s be blunt. Some of the reasons, but not the only ones, why our trade deficits are so large is because government expenditures are too high and/or we are not collecting enough taxes. That is, the US economy is growing too fast for our own good. Having said this, there is no reason to believe that large trade deficits are inherently bad for the economy, which is what the current administration and some of their most influential advisors are arguing. We have a large deficit in the trade of goods, but we have a large surplus in the trade of services. Should other countries impose large tariffs on our exports of services? Think about that until it sinks in!

The first part of our argument above, government expenditures are too high, should appeal to Republicans, so they can go ahead and do what they always say they are going to do but seldom do, that is, lower government spending. The second part, which is not collecting enough taxes, should appeal to Democrats, so they can go ahead and increase taxes, which they are always arguing in favor of.

We have been very clear, over the last several years (see our white paper “Debunking the US National Debt Problem”) about our position that we should do both, slow down government spending and increase tax collections, be it by improving collections and/or raising taxes. We wrote a Weekly on July 12, 2024, in which we compared US tax collections as a percentage of GDP to France. This comparison showed that tax collections as a percentage of GDP in the US, including federal government, state government, local government, and social security tax receipts, amounted to 26.5% in 2021 versus France’s 44.9% of GDP. Of course, we are not arguing that we should go down France’s path, but just an increase in tax collections as a percentage of GDP of about 1% point should do the trick. That is, there is plenty of space, compared to France, for the US to increase tax collections and stabilize the rate of growth of the US debt.

However, the fact of the matter is that none of our political parties are even trying to lower our fiscal deficit. According to the Peter G. Peterson Foundation, the current fiscal proposal in the Republican plan could add $9 trillion to the US debt over the next ten years.1 The Trump administration is justifying the tariffs as an instrument to increase tax revenues. On the flip side, the Republican plan is to lower taxes and make our fiscal issues worse. Furthermore, there is an easier way to lower the fiscal deficit without shocking the US and global economy by engaging in a trade war. As we said above, either slow down the rate of growth of government spending and/or increase tax collections and/or increase taxes or do a combination of all of the above.

We have a bold proposal.2 Here goes. During the Pandemic recession, our debt increased by about $6 trillion as both the Trump and Biden administrations transferred monies to households and businesses. Since the economy is doing well today, let’s pay that money back! Let’s make a payment plan over, let’s say, 10 or 20 years, for households and businesses, to pay that money back. Let’s not call it a tax; and let’s make it temporary, not permanent. Let’s decrease the US debt by $6 trillion in 10- or 20-years’ time. Of course, we must also slow down the growth rate of government expenditures. Again, as we argue in the footnote below, this is the reason why we are not politicians!

1“Full Array of Republican Tax Cuts Could Add $9 Trillion to the National Debt,” The Peter Peterson Foundation, March 31, 2025. https://www.pgpf.org/article/full-array-of-republican-tax-cuts-could-add-9-trillion-to-the-national-debt/

2Our proposal just confirms the reason why we are not politicians, i.e., we will never be elected!

Once again, let’s throw a lifeline to our political class. We actually don’t need to go as far as what we argued in the previous paragraph. In fact, we don’t even need to bring down the debt at all. We just need to slow down its rate of growth. This is why we need to lower the fiscal deficit, fast. Once we stabilize the growth rate of the debt through the lowering of our fiscal deficits, then economic growth will take over and the debt as a percentage of GDP will start to go down.

We still don’t know why we have chosen to increase tariffs (a tax on American consumers) to lower our fiscal deficit. Tariffs are highly regressive taxes, affecting those in the lower income levels more. At the same time, tariffs are highly distortionary taxes that affect production, productivity, and economic efficiency, which threatens the ability of the economy to grow at potential output.

We have written extensively, during the last year or so, on why we do not like tariffs. For example, see the Weekly for February 21, 2025; the Weekly for February 7, 2025; the Weekly for May 24, 2024, just to get a sample of the reasons for our opposition to tariffs. But using tariffs to justify lowering taxes (or just keeping taxes low) and increasing spending/or even not slowing down spending enough, as has been proposed by the Republican Congress makes absolutely no sense.

Although markets celebrated, on Wednesday, the lowering of tariffs on all the countries to 10% with a 90-day pause on the higher tariffed countries while at the same time increasing tariffs on China to a punitive, 145% level, the fact of the matter is that with such a move, the tariff levels will not change much from what it was originally estimated after the announcements on April 2, 2025. That is, we will have the highest effective tariffs in more than 100 years.

In summary, the first step in lowering our trade in goods imbalance is to put our fiscal house in order. While we do that, we can take measures to castigate countries that manipulate their currency and keep it undervalued in order to export more, etc.

Way to make good inflation numbers go to waste

As we have been expecting, inflation is (was?) getting closer and closer to the Fed’s target. This week’s Consumer Price Index report confirmed our expectations by showing a 0.1% decline in prices, month- over-month, while the year-over-year rate slowed down to 2.4% in March, from 2.8% in February. Furthermore, at the end of this month, we expect the PCE price index, which is the rate of inflation used by the Federal Reserve for inflation targeting, to be even closer to the 2.0% target, at 2.2%. However, this is probably water under the bridge and with what is happening to the markets, and what is expected to happen with the implementation of tariffs, this ‘inflation-target-closeness’ will probably be a reminder of what could have happened if we had not embarked on this trade war.

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Employment cost Index: The Employment Cost Index (ECI) measures the change in the hourly labor cost to employers over time. The ECI uses a fixed “basket” of labor to produce a pure cost change, free from the effects of workers moving between occupations and industries and includes both the cost of wages and salaries and the cost of benefits.

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Import Price Index: The import price index measure price changes in goods or services purchased from abroad by U.S. residents (imports) and sold to foreign buyers (exports). The indexes are updated once a month by the Bureau of Labor Statistics (BLS) International Price Program (IPP).

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Producer Price Index: A producer price index(PPI) is a price index that measures the average changes in prices received by domestic producers for their output.

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Source: FactSet, data as of 12/6/2024