Macro Signposts | 18 June 2025

This week, I asked Libby Cantrill, PIMCO's head of public policy, and Allison Boxer, economist, to guest author Macro Signposts and discuss developments in U.S. fiscal policy.

U.S. Policy Watch: From Trade to Taxes

By Libby Cantrill and Allison Boxer

Investors have been grappling with policy volatility this year. While U.S. tariffs on average remain nearly five times higher than before Trump took office, over the past few weeks we've seen Washington pivoting from trade policy to focus on passing the tax and spending bill, while also contending with serious geopolitical developments.

The combination of tax, trade, and other policy changes is complicating the outlook for the U.S. economy. As a baseline, we anticipate slower real growth and higher inflation in the second half of this year, partly due to higher tariffs, with softer activity and employment data likely to prompt the Federal Reserve to cut rates eventually. However, tax cuts stand to provide a boost to U.S. growth in the first half of 2026.

Tax and spending bill: signs of progress in Congress
The Senate Finance Committee is responsible for putting the Senate's stamp on the House version of the One Big Beautiful Bill (its official name, aka OB3), and the committee released its blueprint for the OB3 on Monday afternoon. Senate Republicans seek to navigate several thorny issues to ensure the bill can ultimately pass the Senate chamber (where it can only lose three votes and still pass), while not jeopardizing final passage in the House (where it can only lose two or three votes depending on how many representatives are present).

Releasing the Senate Finance Committee text was critical for Congress to stay on track to meet the July 4 deadline for passage that President Trump has outlined. While July 4 is certainly possible (albeit ambitious) for the tax bill to ultimately pass, we think even if that time frame slips, it won't matter as long as Congress is able to pass the bill by August, the expected month of the next debt ceiling deadline. The upshot is that regardless of what is happening outside of DC, including trade negotiations and the war in the Middle East, we believe that Republicans in DC are focused on delivering the bill to Trump's desk before they take off for their annual August holiday.

However, several outstanding issues with the OB3 may very well remain unresolved after this week, and indeed, the Senate's revised bill may just serve as a placeholder while negotiations continue behind the scenes. Among the outstanding issues:

• The state and local tax (SALT) cap provision. The House version of the bill increases this cap from $10,000 to $40,000, reflecting the views of many House Republicans from New York and California, where SALT matters most. However, far fewer senators are from these states, and in its version the Senate proposed keeping the cap at $10,000 - at least until some compromise can be reached with the House.
• The rollback of the Inflation Reduction Act (IRA) tax credits. Senator Thom Tillis (R-NC) has been leading the charge to soften the rollback. However, this may be difficult given they are large revenue raisers in the current bill.
• Medicaid cuts. Hospital plans in several influential states have endorsed the House version, but the Senate version includes deeper cuts.
• The Senate blueprint of the bill also makes permanent several business tax cuts, such as the expensing of investments in research and development. This is something that Senate Finance Chairman Mike Crapo wants and will likely eventually get, even though the cuts would add to federal deficits.

The Senate blueprint of the bill has not yet been "scored" by the Congressional Budget Office, so we don't know exactly how much it will cost or add to the deficit, but we think the Senate version is likely to add more to the deficit than the $3 trillion estimated for the House bill (over 10 years). On a macro level, the Senate version would likely be incrementally less front-loaded in terms of economic impact than the House version, since it trims some of the more front-loaded provisions (e.g., no taxes on tips), while making permanent other large provisions, which could prove to be more stimulative in the medium and long term.

Tax bill also raises questions for foreign investors
Many investors and businesses outside the U.S. are closely watching the bill's provision on the so-called Revenge Tax, or Section 899. That provision is intended to increase President Trump's negotiating leverage by giving him more outright authority to impose additional taxes on foreign companies (and investors) domiciled in countries that have imposed a Digital Services Tax (DST) or other taxes such as those under the OECD's "Pillar 2." The Biden administration endorsed the Pillar 2 framework, but the Trump administration (and many Republicans and other stakeholders) believe it creates an unfair playing field for U.S.-based companies.

While advocates for the new Section 899 authority assert that it is not meant to be used - just brandished to bolster the U.S. negotiating position - the reality is that even the threat of new capital taxes seems to temper the desire of foreign investors in places such as Europe, Canada, and Australia to invest in the U.S. As such, many stakeholders have been advocating for a kinder, gentler version of the provision that would largely exempt foreign investors.

The Senate blueprint did slightly ease some of the firmer measures in the House version, providing an explicit carve-out for portfolio interest and "other interest and interest-related dividends" (this would likely capture most if not all U.S.-based fixed income products, including Treasuries), a delay in the provision to 2027 (from 2026), a decrease in the maximum amount of tax to 15%, and more discretion to the Treasury Secretary to allow for exemptions. Even with these small changes, the Section 899 provision as it stands now would likely chill foreign investment.

The Senate Finance Committee and Treasury may still be working on this provision, including discussions around broader exemptions.

Trade policy still in background
While tax policy occupies Capitol Hill and the Trump administration focuses on the Middle East, trade seems to have fallen out of the headlines. As a result, markets increasingly seem to be ignoring what has felt like an elephant in the room since April: the upcoming July 9 deadline for many countries to reach a deal with the U.S. or potentially face retaliatory (aka "reciprocal") tariffs. While both President Trump and Secretary Bessent have indicated they would be open to delaying the deadline if negotiations were constructive (and some discussions took place at this week's G7 summit), we would be surprised if we did not see at least some of the reciprocal tariffs resume in July, at least temporarily, for some of the U.S. trading partners.

Regardless of what we see on July 9, however, the average effective tariff rate is still high - roughly 14% and likely to rise when other sector tariffs are imposed - and much higher than the roughly 3% rate we saw at the beginning of this year. Indeed, we're already seeing businesses and households collectively pay billions in additional tariffs: Treasury data show that tariff collections for the month of April would be consistent with tariffs raising $200 billion - $300 billion of revenue per year, equivalent to about 0.7-1.0 percentage points of GDP.

Deficit the continuous loser
While final tax bill details and tariff rates remain under debate, it seems clear that the U.S. fiscal deficit will not be the winner from these policies. Indeed, we've argued since before the election that the U.S. deficit was unlikely to significantly improve regardless of which political party was in office. As a baseline, we expect U.S. fiscal deficits could remain near current levels for the foreseeable future. This implies U.S. fiscal deficits are set to be roughly twice as large as the pre-2017 average indefinitely, at a time when the U.S. debt/GDP ratio already exceeds 120%.

Though the overall deficit outlook appears troubling, tariff revenue should help partly offset some of the cost of proposed tax cuts. And although the tax bill includes some gimmicks such as having tax cuts expire in 2028 (unlikely to come to fruition in an election year), the total cost of tax cuts is set to be somewhat smaller than reconciliation instructions allow. More broadly for markets, extension of the 2017 tax cuts was widely expected after the 2024 election and probably would be no surprise to investors.

Policy crosscurrents complicate the U.S. macro outlook
All these policy changes are complicating the outlook for the U.S. economy and investors. As a baseline, we believe higher tariff rates and lower immigration are consistent with slower real growth and higher inflation in the second half of 2025. After a volatile start to the year for U.S. real GDP as companies and households changed their behavior ahead of and in response to tariffs, we think U.S. real growth could dip below 1% (annualized) in the second half of the year.

We also think that some pass-through of tariffs onto consumers could see the Fed's preferred inflation measure move from "two-point-something" to "three-point-something" later this year. While higher inflation would complicate the path for the Fed, softer activity and employment data may ultimately prompt the Fed to return to rate cuts.

However, several key policy swing factors on the horizon pose risks to our baseline:

• How front-loaded the final tax and spending cuts will be. Because tax cuts would affect paycheck withholding and tax refunds at the beginning of 2026, a more front-loaded bill could boost growth more than current consensus expectations in early 2026, followed by more payback via lower government spending in 2027 and beyond.
• Immigration policy changes. In addition to tax and trade negotiations, the Trump administration recently won several key court cases that will allow more material changes to immigration policy. We think the net result is a growing risk that we'll see a material impact on employment levels as more people leave the country.
• Trade policy changes will feed through to the economic data over time. Last week's U.S. consumer price index (CPI) report showed only modest signs of the impact of tariffs on consumer prices so far. The speed and magnitude with which tariffs are reflected in the economic data remain a key uncertainty.

Catch up on recent editions of Macro Signposts:

• PIMCO Secular Outlook Key Takeaways: The Fragmentation Era | 10 June 2025
• Japan: Rates and Risks Back on the Global Stage | 3 June 2025
• The U.S. Current Account: Trade and Fiscal Deficits Are Closely Linked | 28 May 2025
• Moody's Downgrade Underscores Tensions Over U.S. Debt Outlook | 21 May 2025
• How Does the Data Make You Feel? | 13 May 2025

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