Wishful thinking: the Trump administration's "3-3-3" economic plan

The Trump administration’s economic plan of aiming for a 3% budget deficit, 3% economic growth, and a 3 million barrels per day increase in oil production appears unrealistic. The budget deficit will likely widen as tariff revenue falls short of the cost of Trump’s policies. A stronger economy is unlikely to fill the gap because 3% GDP growth hinges on a record surge in productivity given that deportations will depress weak growth in the workforce. A large increase in oil output seems unlikely because the US is already producing the most oil of any country in history. If the plan fails, record public debt is likely to underpin a further increase in the US neutral policy rate.  

Scott Bessent, the newly-appointed US treasury secretary, recently set out a “3-3-3” economic plan for the second Trump administration, comprising:

1. 3% of GDP budget deficit – more than halve the federal budget deficit as a share of GDP from about 6½% in 2024 to 3% by the end of Trump’s term in 2028 (or c$US1.9 trillion in 2024 to c$US1trillion in 2028 in dollars);
2. 3% GDP growth – 3% economic growth to reduce the budget deficit given tariff revenue falls short; and
3. 3 million extra barrels of oil per day – increased supply to reduce oil prices, lower inflation expectations and keep interest rates low.

All three goals appear unrealistic, so that Trump tax cuts should lead to significantly larger budget deficits and much higher public debt, even allowing for much-needed revenue from new tariffs, with higher debt placing upward pressure on interest rates.

In terms of the first goal, Trump’s tax cuts seem likely to substantially increase both the budget deficit and public debt, even allowing for revenue from Trump tariffs.

As a pre-Trump starting point, the Congressional Budget Office had forecast a relatively modest improvement in the federal budget deficit over the next ten years, estimating a still-historically large average deficit of 5¾% of GDP over the period (or $US22 trillion in total).

In this baseline scenario, continued large deficits increase federal debt held by the public from 98% of GDP last year to a new record high of 118% at the end of the ten years, eclipsing the previous all-time high of 106% of GDP reached at the end of the second world war.

Adjusting this starting point by adding the estimated cost of Trump tax cuts and subtracting the revenue expected to be raised by tariffs significantly worsens the budget position and leads to much higher public debt.

This is because the tax cuts cost more than the money raised by tariffs, with the midpoint of thinktank estimates putting the cost of the tax cuts at about $US8 trillion over ten years, with recently-announced tariffs – i.e., 25% on both Canada and Mexico and 10% on China, broadly equating to a 10% universal tariff – calculated to raise about $US1½ trillion.

On this basis, the average budget deficit over the next ten years would increase from around 5¾% of GDP to 7½% of GDP, lifting federal debt held by the public to an even more alarming 133% of GDP.

Budget estimates spanning ten years are inherently uncertain, as reflected in a wide range of calculations, but the fundamental problem for the Trump administration is that tariff revenue looks likely to fall short of paying for generous tax cuts.

Further tariff increases, such as the threatened “very substantial” tariff on imports from the European Union and additional penalties on China, would reduce the funding shortfall, but Bessent’s plan explicitly depends on 3% economic growth to fill the gap required to achieve his 3% of GDP target for the deficit.

Bessent’s growth target involves raising not only actual economic growth to 3%, but growth in potential output. This is because GDP cannot sustainably grow at a 3% rate without a concurrent improvement in the supply side of the economy, otherwise the Fed would have to raise interest rates to stop the economy from overheating and lifting inflation.

This growth target also seems unrealistic, with the Federal Reserve and the Congressional Budget Office both placing potential growth at about 1¾%.

Illustrating the difficulty in achieving Bessent’s 3% target by breaking economic growth into its drivers, the working-age population was originally forecast to barely grow over the next ten years and Trump’s planned large-scale deportations would result in a weaker outcome.

During the election campaign, Trump talked about deporting 15-20 million people, or about 4-6% of the total population, a seemingly impossible aim given the most deportations over a four-year presidential span totalled about 2½% of the population under Clinton.

Arbitrarily assuming Trump deports about 8 million people of working age, or about 2% of the total population, the working age population would contract over the next ten years.

If this happened, annual growth in labour productivity would have to accelerate from about 1¾-2% over recent years to just over 3% to hit Bessent’s target of 3% economic growth.

This appears unachievable given that the strongest productivity growth in the post-war period was the roughly 2½% average annual increase in the 1960s. 

Also, in terms of the drivers of strong labour productivity, most of them are already highly favourable.

That is, while educational attainment has broadly plateaued over recent years in the US, the ratio of the capital stock to the number of workers and measured technological progress are already both trending higher, albeit where reduced investment in renewables and infrastructure could curb growth in the capital stock.

Failing to lift potential growth to 3% means that there will be no economic dividend to help pay for Trump’s tax cuts, reinforcing the risk that the budget deficit is more likely to widen rather than more than halve to reach Bessent’s 3% of GDP target.

As for the final plank of the “3-3-3” plan, the US is already producing a record 19 million barrels per day of oil, more than any country at any point in history.

It is not clear why producers would want to sell more oil at a lower price by increasing production by 3 million barrels per day, which equals more than 15% of current record US output or 3% of world production.

This leaves the possibility that Musk helps Bessent out, in that Musk has claimed he can cut $US1 trillion from the budget (previously he said $US2 trillion), which is about 3½% of GDP or around 15% of annual outlays.

About two-thirds of federal government spending relates to welfare, health, education, and veterans, with the rest almost equally dominated by defence and interest payments.

Almost half of the budget is nominally exempt from cuts – Trump said he would not touch social security and Medicare, while interest payments will continue – limiting the scope for Musk to reduce spending.

So far, budget cuts have been negligible. For example, USAID has only a $US40 billion budget, with 40% of food aid bought from US farmers, while only 2% of federal workers reportedly took voluntary redundancies versus 6% annual attrition.

More recently, though, Trump has signalled large-scale cuts to the federal workforce, with the US press citing an unattributed reduction of 25%. This figure – which seems highly unrealistic given most federal workers are employed by defence, the postal service, homeland security, and veterans affairs – would reduce outlays by about 1½%.

The potential saving is small because the number of federal employees has been stagnant for decades, with most public servants employed by local government and, to a much lesser extent, state government.

There is also the issue of illegality when it comes to cutting outlays that the administration is currently ignoring, as the president cannot unilaterally stop congress-authorised spending or dismantle or redesign a congress-established agency.

With Bessent’s “3-3-3” plan unlikely to succeed, higher public debt should place upward pressure on the neutral policy rate, which is an important anchor for the financial system.

The neutral rate is unobservable and varies over time, but a range of estimates suggest that it has increased from low pre-COVID levels.

For example, the average of estimates derived from market pricing has increased from about 2¼% prior to the pandemic to about 4% now. Over the same period, the average of Fed model estimates has increased from 3% to around 3¾%, while both surveyed economist/investor/trader estimates and a proxy for the FOMC’s estimate of the short-run neutral rate have risen from about 2½% to around 3%.

Most investors and traders believe that a material increase in public debt would raise the neutral policy rate further, with the median calculation from the New York Fed’s survey of market participants suggesting that a 10pp increase in federal debt as a share of GDP increases the neutral policy rate by 25bp.

This means that if the Bessent plan fails and the estimates of the cost of Trump policies prove reasonable, then a 15pp increase in federal debt held by the public would increase the neutral rate by about 40bp over time. Given that the US neutral rate is a major influence on the neutral rates of most advanced economies, this would place pressure on world short-term interest rates.

This is separate to more general risks to the bond market, such as a potential asymmetric reaction to Trump adopting unrealistic budget assumptions that mask a worse fiscal position, as well as the usual array of possible shocks, including the fact that the US has experienced at least one recession per decade since the second world war and the danger of the US being involved in a war.