Daniel Bunn on Fiscal Issues Currently Facing the US Government

 Daniel Bunn is the president and CEO of the Tax Foundation. In Daniel’s first appearance on the show, he discusses the history of tax models, the threat that tariffs make to the US economy, where we currently stand with budget reconciliation, how he would fix the tax code if he was president, and much more. 

Subscribe to David's new Substack: Macroeconomic Policy Nexus

Check out our new AI chatbot: the Macro Musebot!

Read the full episode transcript:

This episode was recorded on May 2nd, 2025

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

David Beckworth: Welcome to Macro Musings, where each week we pull back the curtain and take a closer look at the most important macroeconomic issues of the past, present, and future. I am your host, David Beckworth, a senior research fellow with the Mercatus Center at George Mason University. I’m glad you decided to join us.

Our guest today is Daniel Bunn. Daniel is the president and CEO of the Tax Foundation. He joins us today to discuss some of the pressing fiscal issues facing the US government. Daniel, welcome to the program.

Daniel Bunn: Thanks so much for having me, David.

Beckworth: It’s great to have you on. You told me before the recording started that you are a longtime listener of the podcast and you have your very own nominal GDP targeting mug even before you came on the program.

Bunn: Yes. A few years ago, you put these things up for sale, and I was like, “Why not?” I added it to my mug collection, and I enjoy using it regularly.

Daniel’s Background and the Tax Foundation

Beckworth: Fantastic. All right. Daniel, you are the president and you lead the Tax Foundation. Tell us both about yourself and your organization.

Bunn: I’ve been in Tax Foundation working in different roles since summer of 2018. Prior to that, I worked for about six and a half years in the US Senate, advising both Senator Tim Scott and Senator Mike Lee. I did some grad school work over in Budapest, Hungary, actually, at Central European University, where I really fell in love with active policy debates and policy analysis to help lawmakers understand where the economic literature is and where that intersects with the decisions they might want to make.

At Tax Foundation, we have different research programs that focus on federal tax policy, state tax policy, and a growing international program as well. I like to say that we’re a very data-focused organization. We have a lot of tools, especially at the federal level, where we utilize our macroeconomic model to analyze changes in federal tax policy and their impacts on revenues, impacts on the economy, and help lawmakers see the different tradeoffs between the levers they might pull on federal tax policy.

We also have some tools at the state level. We have an index that we use to help state lawmakers understand what choices they’re making relative to their peers. There’s always a little bit of healthy competition at the state level for thinking about where rates are, where tax-based design is, and opportunities for being attractive to new investment or folks who are interested in moving from high-tax states to low-tax states.

At the international level, we have a similar index, and we’re also building out some modeling tools there. Our goal is to provide lawmakers with opportunities for seeing ways that the tax code can be changed to support growth and investment and opportunity. We see an opportunity to make sure that the tax code doesn’t stand in the way of success. Really, that flows through all our work. We aim to translate a lot of that data work into solid policy analysis and broader educational tools as well.

Beckworth: You’re really engaged in the conversations now ongoing in Congress. We’ll provide a link to the Tax Foundation’s webpage. I was surprised to see that your work is so wide. It’s not just at the federal level, where we’re going to focus today, but the state and international. You guys have a lot on your plate, a lot that you’re doing. That’s pretty impressive.

Tax Foundation’s Model

Now, tell me a little bit more about the Tax Foundation in terms of its comparative advantage. You mentioned you have a model. I have a colleague, Eric Leeper. He’s an affiliated scholar with Mercatus. He always criticizes the CBO’s model. Now, I know the CBO has to do things according to law, and their hands are tied in certain ways, but he always criticizes their model because it’s not really a general equilibrium model. It has these lines that go up, that the debt-to-GDP gets this ridiculously large number.

He says, “Look, what would happen before you get there? You’d have some crisis or some adjustment, so you’ve got to think through those.” I get the sense that you guys do those type of calculations. Tell us about your model and your comparative advantage at the Tax Foundation.

Bunn: Our model is a product of decades of work. It initially began getting developed by some economists who were at the Treasury Department back in the late ’70s, folks who were very influential in designing the different rounds of the Reagan tax cuts.

The goal was to be able to have a very detailed tax calculator to essentially put the US tax code into a framework where we could take taxpayer data or different economic aggregates and run those through the coded different variables and parameters of the tax code to be able to understand, okay, what’s the impact of this policy just on a very static basis on revenue, but then run that through a neoclassical production function to be able to think through, okay, what does this do in response for labor market response or for capital market investment response? Then how do you allocate those responses across the country into factor incomes?

Our model is a small open economy model. It’s very different than some of the models that CBO uses and some of the other models around the fiscal policy debate. We’re able to identify pretty narrowly the direct impact of tax policy changes on the economy. There’s a bunch of other things. Of course, every model can be open to critique in different ways and everyone’s a partial picture of the world. We feel that we’ve got the partial picture of the world for tax policy pretty down tight.

Now, there are weaknesses to our input data in the sense that we do rely on a lot of aggregated data, especially on the business side of our model. We are more detailed than some others in this space, but not like the Joint Committee on Tax that has access to actual taxpayer data to be able to run their models. I think one of the challenges when it comes to where we are with our level of debt and where we are with the trajectory of that is that different models have some pretty fundamentally different approaches to thinking about that.

For our model, when we see tax policy or fiscal policy that leads to a greater increase in debt, that shows up in the delta between GDP and GNP. Essentially saying American incomes would be lower, but GDP overall might be okay because we have this small open economy framework that foreign capital can flow in. Others might look at that and say, “Actually, well, maybe foreign capital doesn’t quite have the appetite for the level of Treasury issuance and things of that nature.” We are pretty tight in our approach in thinking about the direct impact of tax policy.

Also, if you’re in an overlapping generations model setup, you’re going to be able to think about some of these different trajectories of the debt and the impact of those things. Honestly, with the current situation, a lot of those models have a hard time closing without some sort of fiscal crisis or assuming a massive tax increase in the future.

Beckworth: Your models, in other words, they really take seriously tradeoffs and choices, and that there can be these countervailing effects. You really got to have dynamic analysis or, what we’d say, more of a general equilibrium approach. That’s really neat to see that you guys are working with a model like that.

History of Tax Models

Let’s go back in time a bit and talk about these models in terms of their histories because there was this discussion over dynamic scoring. The Republicans used to talk about, “We’re going to cut taxes and the CBO’s models don’t capture the dynamic effect on the economy,” and whether you would generate enough revenue, you could make up for it or even go past that. The question at the heart of that was what type of model you use. Maybe walk us through that history a little bit and why it’s important.

Bunn: This is a really rich history over the last couple of decades. Tax Foundation, I’m proud to say, played a significant role before I joined the organization in shaping some of that debate. One of the things that economists have known for a long time is that if you change policy variables, there’s going to be a behavioral reaction at some level of the economy. It may not show up in macro data, but we know that people respond to incentives, and the challenge is measuring those elasticities for those responses and how those in a micro setup might translate into macro outcomes.

For tax policy, this has been a long-running debate about, certainly the Laffer curve fits into this, where policymakers think that there’s opportunities to reduce rates and you actually generate more revenue, and different things that you might say might help policymakers make better decisions. Because if you treat, in a very static framework, all taxes equally, then you might end up with pretty problematic tax policy at the end of the day.

What we do is we take the cost of capital very seriously. Through our detailed approach in modeling the US tax code and our tax calculator and how that flows into our production function, we’re able to identify different types of taxes and how they hit different measures of economic activity. Certainly, you can basically think about marginal tax rates on labor income. If you bring those down, you might have a labor supply effect. You might have that on the extensive margin. Intensive margin, we’re able to divide some of that out in our approach.

Then same thing with business investment. If you’re able to reduce the cost of capital, and there’s multiple ways to do that with the tax code, you could think of a tax credit that supports a lower cost of capital. You could think of lowering the corporate tax rate or different things on the definition of income. We spend a lot of time talking about asset depreciation. If you have a long time window over which you have to depreciate a new piece of equipment, that time window is going to increase the cost of capital because you make an investment of $100 today, but you have to deduct that over 10 years. The time value of money, inflation, all of those things, increases the cost of capital for that investment.

We’re able to flow all that through to be able to show lawmakers, “Hey, you can do something maybe on the child tax credit.” Yes, that’s a tax cut, but there’s not a dynamic effect for the broader economy that would support economic growth. You might prioritize those tax cuts, depending on what your politics are and your priorities are. If you want something that supports growth and creates revenue feedback, then you need to do something else.

We’ve been talking about this for a long time, and we developed this taxes and growth model that I’m referring to in the context when lawmakers were really starting to be very interested in being able to nail down what the dynamic effects of the policy choices they were looking at. A lot of the opportunity, I think, for Tax Foundation came out of a post-Affordable Care Act debate, where there was a lot of criticism of CBO’s approach in that, a lot of angst from members about the different data points and modeling procedures, and a desire for outside groups like the Tax Foundation to start weighing in with our own modeling approaches.

That eventually led to lawmakers themselves starting to tell the Congressional Budget Office and the Joint Committee on Tax that they actually do want them to focus on dynamic analysis. That led to some rules around how they might approach dynamic analysis. Tax Foundation is no longer the only game in town when it comes to dynamic analysis of this type. You can certainly look at the Tax Policy Center that is invested in this. They’re at the Urban-Brookings Tax Policy Center. You can look at the Penn Wharton Budget Model, some other folks. You can even look at the Yale Budget Lab.

Honestly, there’s a real wide set of organizations, including the government organizations, that are now all focused on ways that they can sufficiently defend dynamic analysis for discrete policy choices. I think that’s a really good thing because it gives lawmakers a better sense of the tradeoffs that they might make. Not every dollar of spending is treated equally. Not every dollar of tax increases or tax decreases is treated equally.

Beckworth: Yes, that’s great. Let’s do all these models, compare the outcomes across the different organizations. This has been really, I think, important lately with this debate about tariffs. President Trump and some of his supporters are telling us that the tariffs, they will generate lots of revenue. Some of your colleagues have shown that’s not quite the case as he makes it out to be. 

You are someone I follow at Tax Foundation. I also follow your colleague, Erica York. She’s very active on X. I encourage listeners to check out her work. She’s done some really fascinating work on the tariffs and the revenue that it may or may not generate. Anybody else at Tax Foundation we should be following?

Bunn: Yes, absolutely. If you care about state tax policy, you need to follow my colleague, Jared Walczak, who is covering the landscape on that area. My other colleague, Alan Cole, one of our senior economists, is pretty prolific in a variety of topics that he comments on, but very astute in understanding the dynamics of cross-border investment flows and the role of trade and all of this tariff mess that we’re in. Erica is excellent.

I should have mentioned this when talking about our modeling work. One of the things that my value add at Tax Foundation is more on the synthesis side rather than the analysis side. We have a lot of talented economists doing that detailed data work and making sure that our model is as up to speed and putting out the right information as possible.

Beckworth: Great. I’ve had Alan Cole on the program before. I didn’t realize he is now at the Tax Foundation.

Bunn: Yes.

Beckworth: Great addition to your team there. In the future, we hope to have Erica on the program to talk about her work, it’s very topical, what she’s doing. In fact, I’ll provide a link to one of her papers that she wrote with a co-author from the AEI on the tariffs and what it may or may not be able to do.

Fiscal Condition of the United States

All right. Let’s move ahead and just lay the table for the conversation we’re going to have about more recent developments. I think to do that, we need to take stock of the broader trends, Daniel. Where’s the fiscal condition of the US going, the US government, our finances? I just grabbed a few facts from the CBO, and I’ll use that to start this phase of our conversation. This is the CBO projections as of January 2025. Of course, this is going to be quickly outdated, if not already outdated, with a new budget resolution. Trump has his own additions he wants to make.

If I look at that CBO projection, they’re looking at, on average, 17% to 18% of GDP is revenue that we get in, so roughly $5 trillion. We’ve got a $30 trillion economy. Think about $5 trillion. They look at expenditures on the federal government. It’s around 23%, 24%, so $7 trillion. We’re close to $2 trillion in deficits, it looks like, on a pretty sustained basis. Maybe it gets larger over time.

Then, of that, of course, most of it goes to entitlement spending, a lot of that expenditures. Is there much room within those numbers to cut things like discretionary spending? Because today, it’s May 2, President Trump announced he wants this big cut. Most of it, as I understand, is in the discretionary area. Walk us through that. How much wiggle room do people have in terms of discretionary versus entitlement versus interest on debt and defense?

Bunn: I think one of the important things for fiscal policy in the United States generally is that if you’re not talking about the three big entitlement programs—Social Security, Medicare, Medicaid—then you’re really not talking about substantive changes to the future path of US debt. Certainly, the tax side has a role to play in that as well. Discretionary spending is not a large share of the federal budget. Defense discretionary spending actually got surpassed recently by the interest we’re paying on the debt, which is over 3% of GDP right now.

One of the things that policymakers really need to pay attention to, and we saw some fluctuations in Treasury markets just over the last month, is ways that they can address the long-term trajectory of the US debt while also helping markets understand what the near-term objectives they’re going to be using to address that and figure out if they can create some sort of path toward stabilizing that.

The political reality is that all of what I just said in the last two minutes is not going to happen. Unfortunately, policymakers are not super interested in touching Social Security or Medicare. You may see something, and I think it’s very likely that you could see some Medicaid cuts come out of this process that policymakers are working with this year. That could be on the scale of $1 trillion to $2 trillion, depending on divisions between the House and the Senate on what those priorities for cuts are.

That’s meaningful, but that’s also in the context of continuing a lot of the tax policies that actually don’t necessarily help on the debt stabilization side. They could help avoid some challenges on the growth side or offset some of the growth challenges we’re seeing with the tariffs. The problem right now, David, is that there’s not really political leadership that is focused on the fiscal realities that we have in front of us as a nation.

Beckworth: What would it take to get our attention focused on that, to get the public support for something meaningful done, for politicians to really look long and hard? Just to be clear, when we talk about entitlement reform, we’re not necessarily talking about absolute cuts, but we’re slowing the growth, right? Nominal GDP, the dollar size of the economy grows, we just don’t grow them as fast. It would be an effective cut, but it wouldn’t be like an absolute cut. How do we even get to a conversation about that?

Bunn: I think one of the things is the closer we get to a crisis scenario, people are more willing to focus on this. As we saw the volatility in the Treasury market earlier this month, it was very clear that some politicians were interested in saying, “Well, maybe now is the time we need to get things taken care of. Maybe we do need to do something on the revenue side and the spending side this year to make sure that markets are calm and understand that we can get our fiscal house in order.”

That responsiveness to the markets, I think is going to be consistent, but I would rather not have Treasury yields spike before the action is taken. I would rather there be some prudent decision-making. It seemed also on the tariff front that some of the volatility in markets convinced the president to back off the more extreme versions of his plan. What he has done on the tariff front as it is today on May 2 is still very disruptive and going to create a lot of economic harm, but there were worse versions of that even just a couple of weeks ago.

Tariffs and Revenue

Beckworth: Let’s talk about the tariffs and revenue. Now, I was going to get to this a little bit later, but let’s talk about it now since we brought it up. The claim is that the Trump administration would generate a lot of tariff revenue, which would allow the president to cut income taxes meaningfully. I forget the numbers, like $200,000 of income or less would be cut. Huge, huge cut.

Now, I just mentioned we spend about 23%, 24% of GDP on expenditure, so we got to either borrow or generate revenue to get to that. When we had tariffs driving our revenue, I believe it was like we spent 5% of GDP. It was a much smaller number.

Bunn: It was a much smaller government. Yes.

Beckworth: Is this really a practical way to fund the government?

Bunn: Absolutely not. I’m not a fan of income taxes on a principled basis. I would love to see our tax system shift much more to a consumed income or a consumption tax model. You cannot make the math work without absolutely crashing the economy. Then the math certainly doesn’t work for tariffs to raise enough revenue to cut income taxes the way the president has talked about. You can get substantial revenue from tariffs, albeit in a very harmful way. It’s not an efficient way at all to raise revenue, but you can get a couple trillion over the course of 10 years.

What you need is that amount of money every year in order to be able to say you’re substantially cutting income taxes. That’s just not a reality that works with the actual numbers that we see for both trade and for income taxes. This talking point that has been around, it was also around back in 2017 and 2018, where the first time the Tax Cuts and Jobs Act went through and a lot of these income tax cuts went in, the president and some of his advisers were saying, “Well, now that we’ve cut income taxes, we can raise tariffs to make up some of that revenue.”

I think a key theme throughout all of this debate about tariffs is that there’s a real tension and contradiction between the different objectives that the president and his advisers are talking about. On one hand, they can say, “Day in, day out, this is revenue that we can use to do X, Y, or Z.” Then they’re also saying, sometimes different people, but all within the same administration, they’re saying, “Oh, this is leverage for us to get to a much more free trade world. We’re going to negotiate all these deals.” Either you have the revenue or you don’t.

At this point, I think this year, we will see substantial tariff revenue, but it’s not clear how long that policy is going to last. I imagine if the party in power shifts after the next presidential election, that we can’t necessarily depend on this tariff policy being a significant revenue source. We shouldn’t want to depend on tariff policy as a significant revenue source, to begin with.

Beckworth: Even in a perfectly implemented version of tariffs, which we’re not seeing now, to be very clear, but if some kind of stepped-up gradual process at some optimal Laffer curve for tariffs, you still would barely make a dent in the amount of funding you would need. You said you’d get $1 trillion or so over a decade, but you need that much every year.

Bunn: Yes, you would need more than that every year. One of the things that Erica York and Alex Durante, another member of our team, have done is they’ve looked at different levels of tariffs implemented over 10 years and what revenue you can get from them. You can get north of $2 trillion over a decade, but you would need, again, that basically every year in order to really offset the income tax in any meaningful way.

Beckworth: As I mentioned earlier, we’re running deficits on average close to $2 trillion a year, and they seem to be projected under current law, but it looks like it’s going to get worse. Then you also mentioned the interest payments on our debt. They’re now 3%. They’re now as much or more than the defense expenditures. Should we be worried about that? Niall Ferguson, the historian and political commentator, he goes, “Oh, whenever a country reaches the point where they’re paying more on their debt than they are toward the military, it’s a sign of trouble.” Now, I don’t know, maybe that’s true in the past. Maybe it’s just a little fear-mongering now, but should we be worried about that?

Bunn: I always try to take some of those past experiences and their predictive power for the future with a grain of salt, but it’s certainly not good. Whether this is the beginning of a crisis, it’s unclear, but we certainly don’t have our priorities right when it comes to the fiscal health of the nation. One of the things that I’ve started looking at over the past year is more of the share of revenue that goes to paying interest.

For every dollar in tax revenue, it’s roughly 20% of that, and it’s going to grow over the coming years unless something changes. Roughly 20% of that just goes to pay interest. If you think about the different ways people might consider their tax dollars going to the federal government, maybe they do prioritize defense spending, maybe they prioritize some of the health or social security things like that, a growing share of that isn’t even going to fund basic government services. It’s just going to pay interest on the debt.

Back to the modeling point I was mentioning earlier, a lot of that debt is held by institutions or entities outside the US. The gross national income versus GDP gap is showing up in where our tax dollars are going essentially around the world. There are plenty of political points that policymakers make about foreign holders of US debt. That’s not the point I’m making, but it is important for us to be able to get our fiscal house in order so that when US taxpayers are paying into the US fisc, that it’s used for US purposes.

Beckworth: Again, this underscores the point that there isn’t a whole lot of cutting to do on this discretionary side. As the interest payments get larger, as we face growing challenges abroad, security challenges with China, potentially, you really can’t touch those in a meaningful way. You turn to these discretionary, which is getting smaller and smaller. There’s not much to nibble on there, so you have to meaningfully look at entitlement reform. Just like you said, it’s not very easy to do that.

Bunn: I’m honestly open to looking at the tax side as well for additional revenue. You just have to put it together in the right framework. One of the things that we’ve done at Tax Foundation is we’ve looked at different tax hike scenarios and said, “Okay, there are ways you can get net revenue out of a really solid tax reform. How you think about that might change by political party.” You might say, “Well, the Democrats would just go after marginal rates, increase the corporate tax rate, high rates on high earners.” There are other ways you can think about reform. Again, back to the consumption tax model, ways you can both grow the economy and raise more revenue.

Beckworth: When we were discussing tariffs, one of the assumptions that the Trump administration has been making is that foreigners would pay the tariff. We’re already seeing price increases, which means we’re paying it. Is it safe for me to say, to the extent that the tariff is borne by US consumers, that is a tax increase that President Trump has unilaterally applied to the US economy?

Bunn: Yes, absolutely. This is the biggest tax increase since the George H. W. Bush tax increases. The problem with tax policy and how you message it, there’s always this challenge of lawmakers or different public officials mixing up the incidence of tax policy. You say, “Well, this person legally pays the tax, they’re the ones bearing the burden,” but we know, as economists, that that might flow through to consumer prices, that might flow through to lower worker wages or lower investment, lower shareholder payouts, all sorts of different levers of adjustment.

Unfortunately, the president is wrong on both legal incidence and economic incidence here, because the importers legally are the ones who are paying the tariff. It comes to the US and you have to pay your duty before you receive the good. Then the economic incidence, a lot of that does flow through to consumer prices. It’s very close to full pass-through in a lot of circumstances where the tariff does show up at the end state, even if you look through the supply chain, if you’re importing raw materials all the way down to the finished good.

That’s something that the administration has just willfully ignored. Even more than that, there was a conversation earlier this week about Amazon providing a little transparency on the additional duties that would be connected to products that they might sell. I don’t think it was essentially them listing something that would be on amazon.com, but for their freight carriers, being more transparent about the duties they’ve collected. The White House came out against that and said, “Absolutely not. This is a hostile act that you would even be communicating about these tariffs this way.”

From my perspective, tax transparency is a valuable principle. If people understand and see the price they pay and the tax right next to it, that’s actually good. There’s so much obfuscation from the White House on this issue that it’s simply ridiculous and unjustified.

Beckworth: You mentioned the Amazon example. Then recently, he also talked about this doll example where he mentioned, “Look, you may have fewer dolls on the shelves, it may cost a few bucks more, but you still got your dolls.” He’s effectively conceding that we are paying the tax, we are paying higher prices with fewer choices. Again, what I think is troubling to some, including myself, is that this is a tax increase that was imposed by the president without going through Congress. The Constitution says Congress should be the one to get the ball rolling. The president can sign off on it. I was actually delighted to see Senator Rand Paul make this point.

Now, his legislation didn’t make it past the Senate. It was close. It was 49-49. I’m surprised there hasn’t been more pushback from the right, from Republicans about this. This is a tax increase. This goes against their very DNA, right?

Bunn: It goes against their DNA in two ways. One, Republicans generally aren’t in favor of tax increases, as you said. The other one is constitutional and institutional protection. Article I, Section 8 gives Congress the power to levy taxes and negotiate foreign trade and all these different things that are important for Congress to do. Now, they’ve delegated a lot of that responsibility to the administration in different ways. I think the administration is going beyond those delegated responsibilities.

There’s opportunities for Congress to step in and say, “No, we would like to have that power back,” or, “the way the president is using this power, we are going to vote to disapprove of that action.” Really, what you need in that situation is a veto-proof majority. Even more than 49-49, for sure. The dynamic that’s been interesting to watch is when I was working on Capitol Hill right before President Trump came into office, it was clear that he was going to be very aggressive on the trade front. It was also clear that he would have a lot of authorities to do these things unilaterally.

As a staffer working for Senator Mike Lee at the time, I worked with Senator Lee and some others and some folks at Cato Institute and a few other folks around town to develop policy that could say affirmatively that Congress would have a more active role if the president used unilateral authority. A lot of that has progressed to now where there’s new legislation that does similar things, but it doesn’t have quite as broad support as you would need.

Certainly, there was an opportunity during the Biden administration and even leading up to Trump coming back in for bipartisan discussion about limiting the president’s discretion on trade. None of that came to be, and we’re now stuck in this situation where not enough policymakers are willing to assert their institutional authority for better policy outcomes as well.

Beckworth: You mentioned earlier on the tariffs that they could generate some revenue in this ideal world where things are perfectly implemented. The challenge is that they haven’t been implemented ideally. Even in the best-case world, they generate some revenue, not enough, but we’re not even in that best-case world. As you mentioned earlier, there’s a lot of uncertainty. How they make the rules up for the tariffs seems pretty ad hoc. Back and forth, it’s on, it’s off, it’s on, it’s off.

That uncertainty by itself could lead us to a recession or a slowdown, which in turn would affect how much income is collected, how much we’re paying out in social safety net. These tariffs, ironically, could actually lead to a widening of the budget deficit. Is that a fair assessment?

Bunn: It really could. The challenge, as you know, is figuring out whether that recession is going to occur, how deep it is, how long it lasts, and things of that nature, or if policymakers wake up and realize that they’re putting the economy in this situation in a reverse course. Another element of that, though, is the willingness of policymakers to do fiscal expansion into a recession, not just automatic stabilizers with a progressive tax code or things like unemployment insurance, et cetera, but to do active fiscal stimulus in a shrinking economy. That would certainly increase deficits. I think both at the federal level and the state level, there’s different challenges here.

At the state level, all these states have these balanced budget requirements. If there’s this shrinking of the economy, there’s going to be immediate special sessions to figure out where you’re going to plug holes in your budget. I assume a lot of these states are going to look to the tax side to close some of their budget holes if we do end up in a shrinking economy throughout this year.

Beckworth: Let’s cross our fingers and hope that President Trump and other politicians wake up and smell the coffee and realize this is not the brew that they want. 

Bunn: You mentioned something earlier when you were talking about the dolls that President Trump mentioned recently. It brings to mind, I’ve worked both sides of the Atlantic over the years. Over the last decade or so, this degrowth movement has really popped up its head in Europe to the extent that they have massive conferences on degrowth.

Then all of a sudden, President Trump is essentially using a, “Well, maybe it’s worth it if we adjust our trade relationships. We can shrink the economy, shrink consumer options, and things of that nature.” That is just anathema to me. We should be in an abundance mindset, to use the term that’s thrown around a lot recently, but in a mindset of policies that support prosperity rather than limiting the opportunities that people have.

Beckworth: It says something about your policies, if you’ve come to the place where you’re saying, “one, suck it up, buttercup, accept the higher prices, and number two, accept there’ll be fewer choices, fewer supply.” That really says your policy probably isn’t working. As you said, it’s a reduction in economic output. It’s the opposite of what Republicans typically think of. The point we talked about earlier, dynamic scoring, I guess the way maybe to frame it is, are we going to have a positive-sum mindset or a zero-sum mindset? I fear that’s where we’re headed.

You mentioned the degrowthers, and people have made this comparison that we’re slowly lurking into a degrowther mindset, which is, again, I think anathema to what most Americans expect. If you ask most Americans, they’ll tell you they want their children to be better off or at least as well off as they are. What President Trump, to be blunt, is selling is potentially something worse off. I think at some point, this has to hit him across the head. The elections, if nothing else, in the midterm would, to me, be something on his radar.

Bunn: I’m not going to comment too much on the politics of this. One of the things that’s come to mind is the potential for Democrats to run on a tax cut in the midterms and directly connect that to the president’s tariff policy. From US political recent, even long history, that’s an upside-down world where you have that kind of political opportunity for the Democrat Party. Honestly, it will be Republicans who have done it to themselves to create that opportunity.

Budget Resolution

Beckworth: Let’s move on to the last part of our program here and talk about what the House and Senate are doing in terms of a budget resolution. They’re working through the process. As I understand it, the House has put forth a budget that’s going to allow for substantial deficit increases, $2.8 trillion. The Senate even more so, $5.8 trillion. Again, these are estimates. Tell us what is going on here. Why are we adding to the structural deficit? We just got done talking about a cyclical deficit if the economy weakens and the numbers blow up. This looks like, to me, a voluntary choice to expand the structural deficit in the US.

Bunn: The biggest thing that is underlying these budget resolutions and the efforts this year is a desire to extend the tax cuts that were adopted in 2017. The budget rules in the House and Senate essentially limit what can be done, particularly in the Senate, what can be done on a permanent basis if you’re only passing things by a single vote majority in the Senate.

Back in 2017, when the Tax Cuts and Jobs Act was adopted, it was made temporary. The individual tax cuts, some of the tax cuts for noncorporate businesses were made temporary, and some of the provisions for corporate businesses were meant to phase out over the course of time. The corporate tax rate of 21% is permanent in law, so the debate this year isn’t necessarily about that, even though President Trump just earlier this week said he’d like a 15% rate. Makes the math a little bit harder. That is the underlying piece that is driving these budget conversations this year.

Now, the extension of that policy, I think, would be helpful for the US economy. We estimate that if the law is allowed to expire, relative to a world in which the law is allowed to expire, extending those tax cuts could be about a 1.1 percentage point increase in long-term GDP, which is good. There’s some pro-growth elements here, but it’s also not cheap. You can get $4-ish trillion in tax cuts relative to the current path of spending and taxes, and that drives that larger deficit number significantly.

Now, you can pair that with different spending cuts, you can pair that with additional revenues, and you get a full fiscal package. I think policymakers on Capitol Hill are also looking at the tariff revenue and saying, “Well, maybe a whole-of-government approach, this isn’t as fiscally difficult or expensive as you might otherwise assess.”

The challenge here is that there are such thin political margins in both the House and the Senate that, really, there’s one or two members that could disrupt this whole process. What you usually get when policymakers are negotiating with each other in a tight fiscal situation is you don’t necessarily get, “Well, you’re going to spend that money, so I’m going to tax more, and we’re going to offset each other,” but really, you’re going to spend that money, I’m going to spend that money, and everybody’s going to get to spend their money, or everybody’s going to get to do their preferred tax cut. And as you expand the vote count, you also expand the cost of the overall fiscal package.

We’ll see, I think, later this month what the Ways and Means Committee and House actually puts together as a full package on the tax side. There’s the different changes to Medicaid, different changes to other federal programs that could be the spending offsets, but not fully offsetting, to your point, about both the House and the Senate having already agreed to net deficit increase over the 10-year budget window.

Beckworth: President Trump would make that even larger, right, if he could shape it his way?

Bunn: Yes. The things that the president has identified in tax policy specifically would be net negatives for the tax code in a couple of ways. These policies are tax cuts for tips, tax cuts for overtime workers, tax cuts for those earning Social Security. He’s talked about creating an extra tax deduction for interest paid on auto loans, so if you get a car loan, you might be able to deduct your interest.

All of these things increase the cost of the overall fiscal package, and they complicate the tax code. The tips, depending on how Congress writes the rules, assuming they are interested in passing something in line with the president’s preference on tipped workers, you’re going to see, I would expect, very tough language to try to say only these workers in these eligibility categories so that there’s not just this massive hole blown in the income tax where you, myself, other people who are salaried workers, all of a sudden decide that they earn all their income in tips to avoid income tax on that.

Similarly, overtime’s not as harmful in an economic sense. It’d be nice to be able to say there’s a lower marginal tax rate on your next hour of work. That’s not horrible, but implementing that and administering that could be really challenging. You could have workers that decide that, depending on how you write the rules, one month I take halftime and the next month I do more than overtime to try to do some gaming of that.

The tax cuts for Social Security, these are not things that impact long-run growth. These are just net tax cuts. I prefer policymakers to think about tax reform, how we’re making the tax system as a whole better and aiming for the revenue targets that we make, rather than saying, “Oh, we’re going to pick our favorite people and give them tax cuts and be done with it.”

Beckworth: Walk us through how the process will unfold. You already alluded to another month or so, we’ll have some more details. We have upcoming this conversation about the budget, but also we have a debt ceiling moment appearing. Here we are again, and we’re going to have a conversation, and people are going to start to freak out. We’re going to blow the Treasury market up. Walk us through what to expect the rest of this year.

Bunn: This process that we’re talking about is called budget reconciliation. It requires both the House and the Senate to agree on general budget numbers. Those budget numbers also create instructions for individual committees in the House and Senate to come back and report legislation in line with the budget. Then you have a process of passing those pieces of legislation out of committees, stitching all of that into one big package for consideration in the House of Representatives, send that over to the Senate.

Then in the Senate, things can get very difficult, because the Senate has very strict rules about what can be in a reconciliation package. Because what you’re doing in reconciliation is you’re turning the Senate into a simple majority body rather than a body that usually operates on a 60- or 67-vote threshold to be able to pass things. These strict rules say that everything in that legislation has to be budgetary. There are rules about what can be done outside of the 10-year budget window. You can’t increase deficits out there.

There is a discussion about how these policies are going to be measured relative to the budget baseline. That’s a whole other conversation about the wonkeries of the budget baseline and how lawmakers are considering that this year. You get the package from the House. The Senate figures out what it can pass, both from a votes perspective and from the strict rules perspective. Then you have some sort of conference or passing back between the two houses before something gets to the president’s desk.

Another piece of this reconciliation package that you referenced is directly connected to the debt ceiling. You can lift the debt ceiling through this reconciliation package, and lawmakers are really interested in providing some increase in the debt ceiling. There’s different numbers in the House and the Senate, but I think by the time you get to the full package out of the House, there’s probably going to be a number that everybody’s comfortable will get them through enough period of time to be able to mitigate some of those concerns in the Treasury market.

The challenge of hitching the debt ceiling increase to this tax legislation and budget legislation is that you are basically staking the whole game on a couple of big votes in the House and the Senate, and you desperately need enough votes in both of those situations to be able to get this across the finish line and avoid spooking markets. Because if you end up not being able to get this package out of the House, well, that’s going to take some time to work through, “Okay, what are the alternative paths to getting this debt ceiling increase?”

I honestly don’t see a lot of leverage that Republicans have to bring Democrats into a bipartisan debt ceiling increase scenario, especially because of the lack of support that Democrats have for the policies that would be needed to lift the debt ceiling. We’re racing toward, I think, a late summer X date, and we’ll see as the tariff revenue comes in, as tax filing season—that data continues to get wrapped up to see how long the different extraordinary measures will last and what time that will give Congress to put these different pieces of the package together, along with a debt ceiling increase that avoids that panicky moment that we’ve seen too many times over the last decade-plus.

Beckworth: This sounds increasingly dysfunctional but good for you guys.

Bunn: That’s the word for it.

Daniel’s Proposed Solutions

Beckworth: Plenty of work, because it keeps you guys fully employed, so it keeps you busy. Glad there are people like you addressing this. Maybe we could end on this note. We’ve described the challenges, the dysfunction, the concerns. Pretend you’re president of the United States and you have a Congress that’s going to fully support you. How would you get us back on a sustainable fiscal path? What changes would you pass to make America great again in terms of its fiscal health?

Bunn: There’s a few things that immediately come to mind. On the tax side, one of the things that our tax system does not do well is it does not support business investment in the way it should, capital formation, and even the dynamism that we want in small and medium-sized businesses, to be able to grow and be larger businesses. 

There’s a small country up in the Baltics, called Estonia, that has a tax system that’s relatively unique on the world landscape. The approach that Estonia takes to tax policy into business investment is to say there’s no tax on business income until those profits are distributed out of the business. That could be distributions to shareholders, it could be distributions to folks owning corporate debt, interest payments out of the business, and things of that nature. That allows retained earnings and the balance sheet of businesses, balance sheet of financial institutions to be really, really healthy because those assets are utilized for growing that business and reinvesting in research development, new capital equipment, and things of that nature.

We’ve modeled a massive transformation of the US tax system to something like that, alongside a flatter income tax system and a more generally consumption-based tax system. You could do that alongside a value-added tax, and you end up with something that’s positive for the US economy and also positive for US revenues relative to current law.

You end up with this win-win scenario where you’re addressing some of our fiscal situation with higher levels of revenue, and you’re really leaning into this growth-oriented policy reform.

Now, that certainly does not solve the whole picture because you have to do things on the Social Security side, the Medicare side, Medicaid side. I’m less expert in those, but there’s plenty of things off the shelf that would get you trillions of dollars of savings, either bending the curve for Social Security benefits, delaying retirement age, and that would actually benefit both Social Security and Medicare.

There’s different efficiencies in Medicare and Medicaid in the way we subsidize or treat different care facilities or different hospital systems, and the payment structures or reimbursement structures. You can do this, as you mentioned before, without necessarily cutting nominal benefits. You can try to, as much as possible, get to the functional reforms for the system as a whole, especially efficiencies in how you’re interacting with the Medicare and Medicaid system with state governments or with hospital systems and things of that nature, without necessarily cutting too close to the bone on the way the programs are meant to support folks who need the benefits.

Beckworth: There you have it, folks. Reform America just as Daniel outlined it. Check out the Tax Foundation’s website for more discussions on these important topics. Daniel, thank you so much for coming on our program today.

Bunn: Thanks so much for having me, David. It’s been a pleasure.

Beckworth: Macro Musings is produced by the Mercatus Center at George Mason University. Dive deeper into our research at mercatus.org/monetarypolicy. You can subscribe to the show on Apple Podcasts, Spotify, or your favorite podcast app. If you like this podcast, please consider giving us a rating and leaving a review. This helps other thoughtful people like you find the show. Find me on Twitter @DavidBeckworth, and follow the show @Macro_Musings.