Tax Cuts Won’t Cure the Trade War’s Economic Hangover
Extending the TCJA is no match for the lasting damage of tariffs and rising debt
The notion that extending the 2017 Tax Cuts and Jobs Act (TCJA) will magically offset the economic damage from tariffs is a dangerous fantasy. Yet many old-school conservatives — who want to self-soothe about the damage they know President Trump is doing with his tariffs — proclaim it all the time.
We are all for lower taxes and a freer economy. But even we must acknowledge a hard truth: The growth boost from making the TCJA permanent would be modest — on the order of half a percent of GDP — while the drag from protectionist tariffs is several times larger. In simple terms, tax cuts are no panacea for a self-inflicted trade-war wound.
How Much Growth Should We Expect from Extending the TCJA Expiring Provisions?
Proponents of extending the TCJA’s expiring provisions (most of which sunset in 2025) argue it will turbocharge the economy. Indeed, dynamic models show some lift: The Tax Foundation’s model finds that making the individual and business tax cuts permanent would eventually raise U.S. economic output by roughly 1.1% in the long run. (Put differently, it might bump the annual growth rate by only a few tenths of a percent on average.) However, the Tax Foundation assumes that the additional $4.6 trillion in budget deficits has no impact on the capital stock and subsequently no impact on growth prospects.
While many provisions have zero or even negative growth effects (i.e., Child Tax Credit), three provisions alone make up for 0.7% of the long-term growth impact: R&D expensing, bonus depreciation, and interest limitation based on EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). These three provisions combined reap three times more bang-for-the-buck than the lower individual tax rates.
An Economic Policy Innovation Center (EPIC) analysis pegs the gain even lower, at about 0.5% of GDP from a permanent extension of the expiring TCJA provision. In practical terms, we’re talking about a boost in the 0.5 to 0.7% range for long-run growth — not an economic revolution.
Completely out of sync with the most robust economic models, the White House Council of Economic Advisors (CEA) says that in the long run renewing TCJA business tax provisions will raise growth by 1.5%, while renewing individual provisions will raise growth by 1.7%. In other words, the CEA estimates that the combined effect of renewing expiring provisions will boost long-run growth by more than 3%.
Why isn’t the effect greater? In large part, it may be because most of these provisions are already in place, and most taxpayers are expecting them to be extended. The effects of extending the cuts would not be as dramatic as they were the first time, when taxes were higher and lowering them changed the incentives to work, save, and invest.
That isn’t to say that allowing these provisions to expire wouldn’t have a serious negative impact — it would. But renewing existing provisions won’t offer much in the way of additional growth, precisely because expectations for renewing existing tax provisions are already baked in.
When policymakers cut taxes in 2018, it was a significant reduction in the tax burden for American households and businesses. This time around, renewing those provisions is not a reduction in the tax burden, but a continuation of current tax policy.
It’s also worth noting that even the optimistic growth projections assume people respond strongly to lower tax rates by working and investing more. If those behavioral responses are actually weaker (say, because the cuts were already largely anticipated or because other factors like an aging workforce hold back labor supply), the growth bump could be smaller. In fact, we bet that it will be smaller for another reason.
Debt Will Dampen the Supply-Side Effect of the TCJA Extension
These projections do not account for how extending the tax cuts — and increasing the debt — could affect interest rates and economic growth. We know that extending the tax cuts will, at the very least, add $4 trillion to the debt over ten years. But if those tax cuts aren’t offset by cutting spending or closing loopholes, the government will have to borrow more.
The Congressional Budget Office (CBO) tries to account for the economic impact of higher debt. According to the CBO, while extending the TCJA might boost GDP by 0.3% in the short term, the resulting rise in debt would shrink the economy in later years. Larger deficits resulting from unfunded tax cuts would push interest rates higher and crowd out private investment. Based on the economic literature, CBO assumes that every $1 increase in the budget deficit reduces private investment by 33 cents.
The lesson is sobering: Tax cuts can lift growth, but debt-fueled tax cuts have diminishing returns, eventually turning positive growth effects into negative ones as interest rates climb.
Yet, it is much worse than this. As it happens, CBO’s estimates are too optimistic. While most studies suggest that debt places significant upward pressure on interest rates over time, the CBO assumes a debt impact estimate that is about half the effect that most studies suggest. In other words, the CBO is significantly underestimating the impact of public debt on long-term interest rates.
In short, extending the TCJA may not bring about any growth.
Tariffs Will Dampen Growth More Than Often Projected
Now consider the countervailing force: tariffs. Since in office, our self-described tariff-man of a president has imposed a range of import tariffs — effectively, tax hikes on American consumers and businesses who buy imported inputs. These trade barriers act like sand in the gears of the economy, raising costs and sapping efficiency. Mainstream economic models initially projected that the Trump-era tariffs (and retaliation against U.S. exports) would knock off roughly 1% from U.S. GDP in the long run. For context, that’s already more than the TCJA extension growth boost. In practice, we’ve already seen growth slow and investment falter since Liberation Day, and it is only bound to get worse.
However, that 1% GDP hit may actually understate the damage. Economists have identified several limitations in those early models. First, many analyses assumed tariff impacts would be temporary or that businesses could quickly adjust supply chains. In reality, policy whiplash and uncertainty have made firms skittish about investing — a chilling effect not fully captured in a simple tariff model. When CEOs don’t know if a critical component will suddenly cost 50% more due to a midnight tweet, they freeze capital spending and delay hiring. This kind of uncertainty amplifies the economic drag, but it’s hard to quantify. Traditional models also often assume tariff revenue is used to pay down debt (offsetting some harm). Still, they ignore the broader tariff disruption to global supply networks and business confidence.
Perhaps most importantly, early models saw tariffs primarily as a tax on final goods, overlooking how tariffs on imported inputs raised business costs and, by extension, damaged businesses’ ability to invest in new equipment. New research has tried to incorporate these effects. A new Penn Wharton budget model (PWBM) is trying to address this flaw. The new model finds that when businesses bear a chunk of the tariff burden (meaning they don’t pass all costs to consumers), the long-run hit to capital investment is huge, ultimately dragging down GDP far more. In a recent simulation of broad tariffs, PWBM projected a long-run GDP decline of about 5 to 6% by 2054 and significantly lower wages, as higher import costs led to a smaller capital stock.
That’s an extreme scenario, but it highlights a key point: Tariffs don’t just raise prices — they sap the economy’s productive capacity by raising input prices and deterring investment. Even a more moderate estimate suggests the trade war could easily double or triple the GDP loss relative to early forecasts once these dynamics are accounted for. In other words, instead of a 1% drag, we could be looking at a 2–3% (or larger) long-run GDP hit from sustained tariffs.
And hear this. These numbers too could be an under-estimation of the damage caused by tariffs. The PWBM assumes that the debt maturity is mostly long term. In reality, 18 percent of our debt needs to be rolled over every three months, and most of our debt has a maturity of less than three years.
Conclusion
Put it all together, and the math for the economy is bleak. Let’s be optimistic and say extending the TCJA gives us about a 0.6% boost in GDP. Now, weigh that against a plausible 2.5% (or more) drop in GDP due to the tariffs once we account for higher input costs, retaliatory hits to U.S. exports, and rattled investors. TCJA renewal gives an inch, the trade war takes a mile. Even under rosy assumptions, the tax cut extension’s benefit is only a fraction of the tariff cost. We’d still be down about 2% of GDP before considering the additional headwind of rising interest rates from the debt load. It’s akin to trying to bail out a sinking boat with a teacup: You might slow the flood a bit, but you won’t save the ship.
In sum, we absolutely agree that the expiring TCJA provisions should be renewed, avoiding a tax hike for millions of American workers and businesses. But we also recognize the need to fund at least most of the cost of renewal through a combination of reducing spending and closing loopholes. If growth is truly a priority, then policymakers should focus their efforts on provisions that reap the largest bang for the buck, such as making full and immediate expensing permanent. A radical deregulatory agenda would help, too. Finally, we also must be cognizant of the economic environment that we’re now operating in. The ongoing trade war means that the economic boost from tax reform will be drowned out by the economic costs of rising trade barriers.