Tariff revenues to narrow US budget deficit: Fitch

April 09, 2025 (MLN): Tariff revenues will help narrow the US budget deficit in 2025, but the hit to economic growth and additional tax cuts are likely to limit the size of any lasting fiscal benefit, Fitch Ratings says.

Stabilizing US debt/GDP will be challenging as long as long-term spending pressures remain unaddressed.

The tariffs announced on April 2 raise the US Effective Tariff Rate (ETR) to about 25%, compared with the already sharp increase to 18% assumed in Fitch’s Global Economic Outlook for March 2025.

It remains to be seen whether product-specific exemptions, mostly covering pharmaceuticals and semiconductors, are maintained, and if retaliatory measures see trade tensions escalate further.

The magnitude of the ETR increase from 2.4% last year is notionally equivalent to about $800 billion (2.5% of GDP) at steady import volumes and will lead to a meaningful revenue impact this year even at lower import volumes.

Fitch’s most recent baseline projection for the US general government (GG) deficit, which predates the April 2 announcement and references our March ETR assumptions, sees the 2025 deficit narrowing to 7.1% of GDP from 8.1% in 2024.

This already incorporates a significant contribution from tariff revenues, as well as carryover effects from last year’s robust GDP growth and strong financial market performance.

A higher ETR implies a bigger revenue boost, all else equal.

However, we believe the tariffs significantly raise US recession risks and constrain the Federal Reserve’s ability to lower interest rates further given the expected shock to prices.

A sharper economic slowdown would significantly weigh on non-tariff revenues and increase spending via automatic stabilizers.

These effects would lag the immediate revenue boost from tariffs, but we think they would be evident by 2026, along with negative spillovers from financial market volatility.

Fitch’s base-case fiscal forecasts have long incorporated the full extension of the 2017 Tax Cuts and Jobs Act (TCJA).

We assume tariff income will be used for additional tax cuts.

President Donald Trump has proposed further reductions in corporate taxes, as well as exemptions for social security benefits for retirees, tips and overtime work.

Additional increases in state and local tax deductions are also under discussion.

Prospects for large-scale expenditure reductions appear uncertain.

DOGE’s moves to shrink the federal workforce will lead to some savings, but federal civilian workers’ wages and benefits represent less than 5% of total government spending.

For the first five months of FY25 (fiscal year to September 30, 2025), the share of federal government spending was 21% for social security, 15% for Medicare, and 13% each on national defence, health, and net interest.

Data for the same period suggest a significant deterioration, with the underlying federal deficit at $1.15 trillion, compared to $1.83tr for the whole of FY24.

While some Republican lawmakers want to see fiscal consolidation measures offset tax cuts, others have been exploring whether procedural rules can allow the TCJA extension to be scored as ‘current policy’.

This would mean that the revenue impact could be considered as not increasing future deficits, removing the requirement to propose offsetting measures.

This is strongly opposed by Democrat lawmakers.

Still-high deficits would leave our GG debt/GDP projections little changed, with the ratio approaching 120%, more than double the ‘AA’ category median.

Rising GG debt remains among the key sensitivities of the US ‘AA+’/Stable sovereign rating.

Long-standing weaknesses in the US federal government’s budgetary process could result in a crowded summer schedule for policymakers.

Congress passed a Continuing Resolution (CR) in March, avoiding a government shutdown but meaning the federal government has been funded through CRs for the whole of FY25.

Our base-case expectation, consistent with previous experience, is that the 436.1tr debt limit is raised or suspended before cash balances and ‘extraordinary measures’ to meet financial obligations are exhausted.

The Congressional Budget Office estimates that this ‘X-date’ would fall in August or September.

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