Thoughts

July 04, 2025 | 14:16

U.S. Budget Bill: Plenty of Fireworks

Economist

Senior Economist and Director
Economics

Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with over two decades experience as a ma... (Read more)

Sal Guatieri

Senior Economist and Director
Economics

Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with over two decades experience as a ma... (Read more)

Just in time for the President’s Independence Day deadline, Congress passed the sweeping One Big Beautiful Bill Act. The highlights include:

On the tax side for persons:

Extends the 2017 tax cuts
Exempts tips and overtime pay from taxes (up to a cap) starting this year
Provides an additional tax deduction for seniors
Enhances the standard personal deduction and the child tax credit
Increases the SALT deduction cap to $40,000 from $10,000 starting this year

On the tax side for businesses:

Increases limits on immediate expensing of investments and expands the depreciation deduction for building production facilities (including full immediate expensing of new factories). This dove-tails with the reshoring goal
Cuts nearly $500 billion from Biden-era clean-energy tax credits and subsidies

On the spending side:

Boosts funding for the military and border-control policies
Cuts Medicaid funding partly by imposing work requirements and tightening eligibility rules based on immigration status (this reduces the budget deficit by $884 billion over ten years, says the Penn Wharton Budget Model, or PWBM). Trims Medicare funding and reduces subsidies for persons buying private health care via the Obamacare system. The Congressional Budget Office estimates nearly 12 million people will lose health insurance
Reduces spending on the food stamps program. The CBO estimates 4.7 million people will lose access
Limits student loans, reducing funding by $387 billion over ten years

The PWBM estimates the Act will increase the budget deficit by an additional $3.2 trillion over ten years relative to the current baseline (and by over $400 billion in FY2026 after a modest trim in FY2025). That’s in line with the CBO’s ten-year tally of $3.3 trillion, which sees the Act lifting annual deficits by an average of just over 1 ppt of GDP to about 7% over the next decade, while hiking the federal debt (held by the public) from around 100% of GDP to over 120%, well above the record high (106%) reached in WWII. The Committee for a Responsible Federal Budget sees an even larger 10-year lift of $3.4 trillion, with the extended 2017 tax cuts contributing $2.2 trillion. This excludes additional interest payments of about $700 billion, on top of the current running 12-month total of nearly $1 trillion. The FY2024 deficit of $1.8 trillion (6.4% of GDP) and 12-month tally of $2.0 trillion to May could be headed well north of $2 trillion in 2026. The Administration and Congress are betting that the Act will stimulate investment and growth sufficiently to limit the fiscal damage and corral the increase in interest payments. Tariff revenue will also help. The Act also raised the debt ceiling by $5 trillion which, given the increased rate of borrowing, will become an issue again in a couple years.

Estimates of the Act’s effect on real GDP over the full ten-year period range widely from a meaningful lift (1.3% Tax Foundation) to a slight drag (-0.3% PWBM). The Tax Foundation sees a modest 0.2-ppt add to growth in 2025 followed by a more substantial lift of around 1 ppt in 2026. We are assuming the Act will provide a moderate lift in 2026 after nearly a wash this year, aligning with our current call of growth improving to 1.7% (on a Q4/Q4 basis) from 1.0% in 2025.

For 2025, DOGE-related spending cuts along with deportations and immigration curbs will weigh, with the latter likely already showing up in the workforce data. The increased funding for immigration enforcement will accelerate deportations. But this growth hit could be offset by the front-loaded tax cuts for households and businesses. Employer withholding rates on overtime pay and tips will be lowered immediately, putting extra money in workers’ pockets. The extension of the 2017 tax cuts merely maintains the status quo and won’t impact personal income or profits, but its permanency could have a small positive effect on confidence and investment.

For 2026, the overall economic effects remain uncertain, but the tax cuts and spending increases for defence and the border are likely to more than offset the rolling back of clean-energy subsidies and cuts to health care insurance and food stamps. This will drive up the budget deficit while lifting overall growth.

Bottom Line: While the economic effects of the OBBBA aren’t clear, we suspect the front-loading of tax cuts will override some of the more back-loaded spending cuts and provide a moderate lift to growth next year, as largely assumed in our forecast. But the many moving parts in the Act and the unknown reaction of businesses and households, coupled with the still lack of clarity on the trade file, could greatly alter the growth picture. For the Fed, the expected stimulative effect on the economy could reinforce a go-slow approach to easing. However, the growth lift may not be large enough to fan inflation, especially given some supply-side response to tax cuts, keeping the Fed on track to gradually restore policy neutrality from the current modestly restrictive stance.