Independence Day: The real cost of the "big beautiful bill"

While the country celebrated Independence Day, the non-partisan budget scorekeepers delivered a grim verdict on the new fiscal law. The Congressional Budget Office projects that the OBBBA will add about $3.4 trillion to federal deficits over the coming decade, and that is after allowing for optimistic assumptions about dynamic growth.

A law passed by a whisker

The margins tell their own story. The Senate passed the bill on 1 July by 51 votes to 50, with the vice-president breaking the tie, and the House followed on 3 July by 218 to 214 after a night of pressure on holdouts. The president signed it on the holiday itself. At each stage the arguments over cost were settled by political deadline rather than by changes to the numbers, which is how a measure that adds trillions to the debt passed a Congress whose majority campaigned on fiscal restraint.

Scoring by baseline

The Senate made the bill look cheaper by changing the yardstick. Its leaders measured the cost against a baseline that assumed the 2017 tax cuts would continue anyway, so extending them was scored as costing nothing. On that basis the law appears to reduce deficits. The budget office's figure uses the conventional baseline, under which current law, including the expiry of the old cuts, is the point of comparison. The cash the Treasury must borrow is the same under either method; only the accounting description changes, and bond investors lend against the cash.

Growth won't cover it

Much of the debate in Congress rested on the claim that 100 per cent bonus expensing and lower statutory rates would spur enough growth to pay for themselves. The CBO’s modelling does not support it. Incentives for capital investment do give potential real GDP a modest lift. But the extra tax revenue from that growth offsets less than twenty per cent of the gross revenue lost. The other eighty per cent will have to be borrowed, year after year.

There is a further drag that supporters rarely mention. Larger deficits mean more government borrowing competing for the same pool of savings, which pushes up interest rates at the margin and discourages some private investment. Budget models that include this effect find that the growth dividend from tax cuts is partly eaten away by the higher cost of capital the deficits create. A law that relies on investment for growth is also raising the price of the money that investment needs.

Interest on interest

Federal debt held by the public already exceeds 100 per cent of GDP. Borrowing another $3.4 trillion on top will make net interest costs compound quickly. By 2030 the government's interest payments will be larger than its combined discretionary spending on education, infrastructure and veterans' affairs.

The mechanism is unforgiving. Much of the debt was issued when rates were close to zero, and the average rate the Treasury pays is still below today's market yields. As old bonds mature and are refinanced at current rates, the average rises even if yields stop climbing. Every extra dollar borrowed under the new law then adds its own interest bill, which is itself borrowed. Even before the law, the budget office projected that debt held by the public would surpass its record of 106 per cent of GDP, set just after the second world war, by 2029.

The federal government already spends more on interest than on defence, and net interest is approaching a trillion dollars a year. That is money that buys no service, builds no road and pays no pension. It flows to bondholders, a large share of them foreign or wealthy, which also gives the rising interest bill a distributional twist that rarely features in the debate.

The 1990 correction

America has been here before. The tax cuts of the early 1980s were followed by persistent deficits and rising interest costs, and in 1990 the first President Bush broke his pledge against new taxes to agree a budget deal with Congress that raised revenue and capped spending. The deal cost him politically, but it set up the fiscal improvement of the 1990s. The lesson is that correction tends to come only when interest costs and market pressure make the status quo impossible to defend, and it usually costs the politicians who deliver it.

Where the case for calm fails

The strongest argument for calm is tariff revenue. Customs receipts have climbed to record levels this year, and the budget office has acknowledged that tariffs, if kept in place, could offset a large share of the law's cost. That is a real consideration. It is also a fragile one: the broadest tariffs face a legal challenge that has already gone against the administration in the trade court, rates are being cut in trade deals, and tariffs that shrink imports also shrink the base on which the duty is collected. A permanent tax cut financed by a temporary and contested revenue source is still a deficit.

America's ability to borrow in its own currency and to issue the world's main reserve asset gives it room that other governments lack. Room is not the same as immunity, as the loss of the last AAA rating in May and the rise in long-term yields this spring both suggest.

What to watch

The indicators are the Treasury's next quarterly refunding announcement, which will show whether it plans to raise the size of its note and bond auctions, demand at auctions of ten- and 30-year debt, and the budget office's updated projections later in the year. The headline price tag is the smaller problem. Within five years or so interest will cost Washington more than several of its biggest programmes put together, and future Congresses will find themselves borrowing simply to pay the interest on earlier borrowing. The first visible cost will probably be larger auctions of long bonds within the next year, and with them a higher term premium that every mortgage holder and corporate borrower in the country will pay.