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Twin Deficits: Mind the Gap(s)

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Twin Deficits: Mind the Gap(s)

As the Trump administration looks to implement increasingly protectionist policies in an effort to fight a widening trade deficit, the president may find the culprit a little closer to home.

The combination of tax cuts associated with the 2017 tax reform and higher spending in 2018 and 2019 following the 2018 bipartisan budget agreement will likely widen the U.S. fiscal deficit to $991 billion by 2020. The federal deficit would be more than double the $439 billion of 2015--its recent low. (It was a beastly $666 billion last year.) As a percentage of GDP, the federal budget deficit could widen to 4.5% in 2020, from 3.5% in 2017.


  • Based on S&P Global Economists' analysis of tax cuts and increase in government expenditures in the pipeline, the U.S. fiscal deficit will likely expand to $991 billion by 2020. According to our review, the current account deficit, a broader measure of trade, will be $700 billion by 2020.
  • Free trade isn't necessarily to blame for this--and protectionist policies may not be the answer.
  • Helping fuel the twin deficits is low domestic productivity, which propels the purchase of cheap foreign products.
  • Since the U.S. consistently spend more than it saves, Uncle Sam will likely become more reliant on foreign capital inflows to fund its deficit.
  • While deficits aren't necessarily bad, the debt necessary to finance the deficit may create large and persistent imbalances, increasing risks of reaching unsustainable levels.

What stands out this time around compared with past business cycles is that the trajectory of fiscal deficit has reversed from its path of reduction, even as the current unemployment rate would seem to indicate that the economy is near full employment. Despite rapid improvement, the deficit was still larger as a percent of GDP for fiscal years 2016 (2.6%) and 2017 (3.5%) than it was at the end of any other expansion./p>

Tax cuts will likely give the U.S. households and businesses a near-term incentive to consume. S&P Global economists don't expect the tax cuts and increased government spending to appreciably boost the economy's potential growth rate by triggering an acceleration in the labor force or total factor productivity growth above our long-term baseline projections--this likely means a lift to consumption and investment with only modest productivity gains. The stronger economy also mean higher imports, meaning more money could end up overseas, purchasing relatively cheaper products than in the U.S., thus widening the trade deficit.

The widening fiscal deficit contributes to a wider current account deficit, a broader measure of trade, to around $700 billion by 2020, from just $465 billion last year. Data since 1980 shows that the current account deficit doesn't necessarily have to widen with fiscal deficit if household savings go up or private investment goes down, or some combination of the two. We do not expect private investment to go down in the coming years, nor do we expect household savings to go up. As a result, we expect the second twin--the current account deficit--to reach about 3.3% of GDP by the end of 2020. This represents a higher deficit than recent lows, but still 3 percentage points below what was back in 2005-2006. Given the low savings rates in the U.S., the deficits will make the economy more reliant on inflows of capital from abroad.