By Guangzhou (Albert) Hu

On July 4, US Independence Day, the much-anticipated “Big, Beautiful Bill” officially came into effect with the signature of US President Donald Trump. This bill, which has passed both chambers of Congress, has sparked significant controversy due to concerns that it could further exacerbate America’s fiscal deficit and debt risks.

In this article, CEIBS Professor of Economics Albert Hu offers a brief analysis of how the largest tax cut legislation in US history may impact the American economy, as well the bill’s implications for China.

The core of the “big, beautiful bill”

The core of this new tax and spending legislation is the extension of the tax cuts that originally introduced in 2017 during Donald Trump’s first term, which were due to expire at the end of this year (these were mainly individual income tax reductions). The “big, beautiful bill” can therefore be seen as continuing existing tax policy rather than launching a new round of large-scale tax cuts. In other words, without this huge bill, US individual income tax rates would be due to rise significantly after 2025, an outcome clearly unacceptable to Trump.

Trump’s Republican Party has consistently advocated seeking to stimulate economic growth, create jobs, and raise household incomes through tax cuts. The economic logic behind this idea is that tax cuts increase corporate profits, thereby strengthening firms’ willingness to invest. Higher investment can lead to improved productivity and enhanced competitiveness, which in turn lays the foundation for rising wages for workers.

The 2017 Tax Cuts and Jobs Act (TCJA) reduced the US federal corporate income tax from a top marginal rate of 35% to a unified rate of 21%, bringing it below the average corporate tax rate of OECD countries and further boosting the US’s attractiveness to global investors.

Lowering tax rates inevitably results in a short-term decline in tax revenue, and if government spending remains unchanged, the fiscal deficit will therefore inevitably increase. Since the presidency of Ronald Reagan in the 1980s, there has been a view within the Republican Party that one should not be overly concerned about the fiscal deficit resulting from tax cuts, because lower tax rates are expected to spur investment and drive economic growth. Once the tax base expands, government tax revenues will also rise, offsetting the revenue losses caused by the cuts.

One of the most extreme representations of this theory is the “Laffer Curve” proposed by US economist Arthur Laffer. The Laffer Curve suggests that there is an inverted-U-shaped relationship between government tax revenue and tax rates: when tax rates exceed the optimal rate (the rate that maximises tax revenue), lowering tax rates will not reduce revenue but, on the contrary, will actually increase fiscal income.

The implications of financial deficit and government debt

Trump and his supporters have consistently emphasised that tax cuts will not exacerbate the government’s fiscal deficit. But is this true?

In 2017, Harvard Professor of Economics N. Gregory Mankiw, commenting on the effects of Trump’s TCJA, summarised the findings from economic research: he believed that only around one-third of the revenue losses caused by tax cuts could be offset through economic growth effects.

In 2024, three economists from Harvard, the University of Chicago, and Princeton studied the impact of the TCJA’s reduction in corporate tax rates on the US economy. Their main conclusion was that while the tax cuts did indeed stimulate business investment, which in turn supported economic growth and raised wages, the effects were nowhere near as substantial as Trump and his supporters claimed—and these growth effects fell far short of offsetting the decline in tax revenues.

Fiscal deficits and government debt are two sides of the same coin: the former is sustained by the latter. In 2024, the US federal government’s fiscal deficit reached 6.6% of GDP, among the highest levels in history (excepting the periods of the 2008 financial crisis and 2020–2021 COVID-19 pandemic). Each year’s new deficits keep adding to the government’s debt. By 2024, US federal debt had reached nearly $36 trillion, equivalent to about 123% of GDP, both record highs.

Estimates from various US institutions suggest that the “big, beautiful bill” will add an additional $3 to 4 trillion in fiscal deficits over the next decade, further increasing the share of government debt relative to GDP.

It is noteworthy that high government debt, in turn, makes reducing deficits much harder. In 2024, the US federal government’s interest payments on debt surpassed defense spending, becoming the third-largest source of federal expenditure, behind only Social Security and Medicare.

So how do persistent fiscal deficits affect economic growth? As the government keeps borrowing to sustain the deficit, the supply of Treasury bonds must rise, pushing up interest rates. This crowds out private investment and hampers growth. The most pessimistic estimates come from Yale economists, who believe that in the long run, Trump’s new package will significantly lower the US economic growth rate.

Of course, the US has more fiscal space than other countries, partly because the dollar’s unique status as the world’s reserve currency has reduced the financing costs of the US government. Theoretically, US Treasury securities carry no default risk, since the US issues debt in its own currency. However, the risk of US debt devaluation does exist, and may even rise as debt levels keep climbing. The market’s massive sell-off of US Treasury bonds after the Trump administration escalated its trade conflict with China this April was a notable signal.

During his presidential campaign, Trump pledged not to increase the level of federal government debt. Some suggest that the deficit could be reduced by cutting government spending. The Department of Government Efficiency (DOGE) once led by Elon Musk attempted to eliminate unnecessary spending across government agencies, but so far has achieved little.

To understand the difficulty of cutting federal government spending, let’s briefly look at how the budget is structured. Of the $6.8 trillion in federal spending in 2024, the five largest items together account for 70%: Social Security (22%), Net Interest Payments (13%), Medicare, i.e. medical insurance for the elderly (13%), Defense (12.5%), and Medicaid, i.e.  health insurance for low-income individuals (9%).

Under US law, Social Security, Medicaid, and Medicare are considered mandatory spending, which cannot be changed unilaterally by the executive branch or Congress without new legislation. Defense spending is discretionary, set annually by the President and Congress, while interest payments are a category unto themselves.

Cleary, these are all highly inflexible expenditures. Social Security and healthcare are directly tied to the American peoples’ livelihoods and, therefore, their votes, and spending in these areas will only increase further as American society ages. In today’s geopolitical climate, meanwhile, defence budgets are more likely to rise than fall. In fact, Trump’s “big, beautiful bill” will increase defense spending by $150 billion.

Ultimately, Trump swung the budget-cutting knife toward low-income people's health insurance, aiming to reduce enrolment by tightening eligibility requirements (for example, requiring beneficiaries to show proof of employment), thereby lowering healthcare spending. The “big, beautiful bill” is projected to cut $1 trillion in expenditure over the next decade, but this still falls far short of offsetting the $4.5 trillion in lost revenue from tax cuts. Meanwhile, millions of low-income families could lose health coverage.

Overall, the “big, beautiful bill” has injected a great deal of uncertainty into the long-term sustainability of US federal finances by extending and perpetuating the TCJA’s tax reductions, while the long-term growth benefits of these tax cuts remain unclear.

The impact of income, wealth distribution and trade deficits

Above all, the bill will have profound implications on two aspects of US society and economy: income and wealth distribution, and the trade deficit.

Reductions in individual and corporate income tax rates, as well as higher exemptions on taxes including the estate tax, will grant the wealthiest 1% of Americans an estimated $1 trillion in tax benefits over the next decade. Meanwhile, the loss of health insurance and other government benefits will make low-income groups the losers under this bill. This will undoubtedly exacerbate income and wealth inequality in American society and pose even greater challenges to the US political system.

Many of Trump’s own supporters rely on Medicaid for healthcare. Whether this group will waver in their loyalty to Trump because their own interests are now being harmed is an open question worth watching.

Another major focus of Trump’s economic policy is addressing America’s international trade imbalance. The Trump administration has resorted to extreme measures to reduce the US trade deficit. But, in reality, large fiscal deficits make it even harder to balance America’s international trade.

The fundamental cause of the US’s overall trade deficit is the country’s low savings rate. In simple terms, Americans spend more than they earn. Sustained high consumption can only be maintained by borrowing from abroad (i.e., importing more than exporting), and the federal government’s budget shortfalls will only worsen this situation.

Indirect impact on China

In the short term, the “big, beautiful bill” is, on the whole, a positive development for China’s economy. As US-China trade tensions ease, the bill’s economic stimulus is expected to translate partially into increased demand for Chinese goods, helping reduce the pressure on China’s economy as it transitions from an export-driven to consumption-driven growth model.

Another point worth noting is that the “big, beautiful bill” repeals policy subsidies introduced by the Biden administration for certain renewable energy sectors (such as wind and solar), including a $7,500 tax credit for electric vehicle purchases, and aggressively promotes fossil fuel development. On this front, the Trump administration is clearly on the wrong side of history. These policies will further delay the already lagging progress of the US renewable energy sector and represent a step backward for the country’s energy transition as a whole.

The removal of tax incentives for EV purchases will, however, have limited direct impact on China’s electric vehicle industry, as the Biden administration had already made efforts to block Chinese EVs from entering the US market.

The impact on other Chinese renewable energy companies (such as solar and lithium battery manufacturers) should also be manageable, since exports to the US make up only a small portion of their overall output.

Trump’s preferences regarding fiscal spending priorities are reflected not only in the “big, beautiful bill”, but also in his administration’s proposed budget.

To rein in government spending, Trump cut the budgets of the National Institutes of Health (NIH) and the National Science Foundation (NSF) by 40% and 50%, respectively, in the 2026 budget (these fall under discretionary spending, determined annually by the President and Congress). Nearly all new drugs approved by the FDA between 2010 and 2019 received National Institutes of Health (NIH) funding during their development. Additionally, 174 Nobel laureates have either been supported by or worked within the National Science Foundation (NSF).

For American scientists, these two institutions are the most important sources of research funding. Without them, the US would not possess its globally leading strength in basic scientific research, an advantage that underpins its status as a technological superpower.

Amid intensifying US-China competition in science and technology, Trump's cuts in funding for basic research could become a long-term liability for the US. This may lead to scientists who are unable to secure adequate funding in the country seeking opportunities elsewhere, including in China, to continue their work.

The nature of the US political system means that American politics and policymaking tend to swing between left- and right-wing visions. The “big, beautiful bill” was passed largely due to Trump’s personal influence and authority over the Republican Party. How that influence and authority will evolve as the bill’s economic and political consequences become more apparent, and as the US enters a new election cycle, remains to be seen.

In any case, the ever-growing US fiscal deficit is a challenge that cannot be ignored by either the US or the global economy as a whole. Trump’s landmark tax and spending bill is sure to have a profound and uncertain legacy for the US economy.

Guangzhou (Albert) Hu is Professor of Economics at CEIBS. His research interests center on the economics of technological change and the Chinese economy.