Can the US Attain 3% Growth and Budget Deficit Goals, or Is It Nearing a "Minsky Moment"?

Scott Bessent, nominated for Secretary of the US Treasury Department, suggests an economic strategy targeting 3% GDP growth with a 3% budget deficit. Yet, Paul Tudor Jones, the founder of Tudor Investment, cautions that the US is nearing a "Minsky Moment," recognizing what is "fiscally and financially impossible." Considering the promises made by the new administration, which have fueled irrational exuberance in the financial markets, the risk of a Minsky moment is not negligible.

The US Fiscal Situation

The United States is currently facing a budget deficit that equals 6% of its GDP. Reducing this gap by half is a substantial challenge, which would be further complicated by the upcoming administration's intentions concerning existing tax legislation, not to mention any new tax cuts they may try to introduce.

By the end of 2025, the individual tax cuts introduced in 2017 will expire. Continuing the existing tax regulations for individuals would decrease federal revenues by $3.3 trillion over the following ten years, raising the budget deficit/GDP ratio by 75 basis points each year compared to what it would otherwise be, according to the CBO and other independent advisory firms.

However, here's the twist. The 2017 tax reform increased GDP growth by 0.3 to 0.4 percentage points per year over the subsequent three years. However, simply extending the existing tax law does not provide any incremental growth, as it does not increase the cash flow of individuals. For the consumer, its a net zero. Consequently, extending current tax law enlarges the budget deficit without offering any boost to growth.

Thus, to steadily and significantly reduce the budget deficit over several years, it would have to be achieved solely through spending adjustments. However, the question remains: how much can federal spending be reduced annually without negatively impacting the economy's performance?

To simply counterbalance the lost revenue from extending the 2017 tax law, the new Secretary of the Treasury would need to enact spending cuts of $350 billion annually, and potentially double that amount to ensure the budget deficit consistently decreases.

Every dollar the federal government spends eventually reaches individuals, businesses, or state and local governments. While it is possible to reduce federal spending by $700 billion through legislation in a year, is it politically viable? If it is, what impact would it have on economic growth?

At $29 trillion, nominal GDP growth of 5% (3% real and 2% inflation) generates an extra $1.5 trillion in output or income in a year. It is not possible take $750 billion of government spending out of the economy, and still expect the economy to grow 5%.

Paul Tudor Jones, the founder of Tudor Investments, recently stated, “Will we have a Minsky moment where all of a sudden there’s a point of recognition that what they’re talking about is fiscally impossible, financially impossible?” Considering the promises made by the new administration, which have fueled irrational exuberance in the financial markets, the risk of a Minsky moment is not negligible.