[Interview] "Trump's Second Term, Tariff Hikes Could Cause 'Oil Shock'-Level Impact... Global Prices Will Rise Further"

[Trump 2.0 US Expert Interview] ③
Jeffrey Frankel, Harvard Kennedy School Professor
Tariff Hikes Fail to Offset Income and Corporate Tax Revenue Losses
US Fiscal Deficit and Debt Worsen... Spending Cuts and Tax Increases Needed
Concerns Over Tariff-Driven Inflation Rise and Real Income Decline
Controversy Over Fed Independence Infringement
Policy Contradiction: Advocating Weak Dollar but Implementing Strong Dollar Measures

"Trump's tax cut policy has caused a sharp increase in the US fiscal deficit, raising serious concerns about significant aftershocks. His promised tariff hikes are also expected to trigger supply shocks comparable to the 'oil shock,' leading to global price increases and a decrease in real income."

Jeffrey Frankel, a global economic scholar and professor at Harvard Kennedy School, stated in a video interview with Asia Economy on the 11th (local time) regarding the macroeconomic outlook after Donald Trump, the 47th President-elect of the United States, takes office, "Trump's tax cut policies, such as reductions in income and corporate taxes and exemptions on tips and Social Security benefits, will have very harmful effects on the federal government's fiscal deficit and national debt."

President-elect Trump plans to lower the top corporate tax rate from the current 21% to 15% and permanently extend tax cuts set to expire next year, including income tax reductions. With his landslide victory and the Republican Party controlling both the House and Senate in a 'Red Sweep,' Trump's tax cut policies are likely to easily pass through Congress and become a reality.

Professor Jeffrey Frankel, Harvard Kennedy School

Professor Frankel assessed that it is difficult to expect economic benefits from the tax cut policies he promised. He particularly emphasized the need for concrete evidence regarding the growth rate increase and medium- to long-term tax revenue increase effects through corporate tax cuts, stating, "Anyone can say that productivity will greatly increase through such policies, but specific evidence must be provided," and pointed out, "Trump's promised tax cut policies cause a real problem of increasing debt in the long term." He added, "Both the financial market and the non-financial private sector will be concerned about national debt," explaining, "This is why it is difficult to consider Trump's tax cuts as a business-friendly policy."

Known as the 'Tariff Man,' President-elect Trump intends to offset the revenue loss from income and corporate tax cuts by raising tariffs. He has already announced universal tariffs of 10-20% on all countries and 60% tariffs on China to resolve the trade deficit. Professor Frankel dismissed this as "impossible." He said, "Trump overestimates the revenue increase effect through tariffs," adding, "The tax cut scale is so large that even raising tariffs cannot compensate for the reduced tax revenue." According to the US Tax Foundation, if income tax cuts are made permanent, federal government revenue is estimated to decrease by $4.2 trillion over the next ten years. Raising universal tariffs by 10% is expected to increase tariff revenue by $2 trillion over ten years, and by 20% would increase it by $3.3 trillion. Even if the US applies universal tariffs of up to 20% on all imports, it cannot cover the revenue shortfall caused by income tax cuts.

Professor Frankel expressed concerns about the global macroeconomic aftershocks caused by tariff hikes initiated by Trump. He said, "If Trump raises tariffs as promised, US consumer prices will rise and real income will decrease," adding, "If other countries retaliate against US tariff hikes, inflation will rise not only in the US but in all countries worldwide, reducing real income and purchasing power, negatively impacting global growth rates." He also mentioned the possibility of shocks comparable to the 'oil shock' or 'natural disasters.'

With the launch of Trump's second term, the already serious US fiscal deficit problem is expected to worsen. Professor Frankel stated that drastic measures such as reducing government spending and raising taxes are inevitable to break the cycle of worsening fiscal deficits. He emphasized, "The Social Security system must be stabilized by raising the retirement age and adjusting tax rates," and "Reforms are needed in various areas, including government spending and taxation." He criticized, "Despite the fiscal deficit problem worsening compared to decades ago, policymakers and Congress are surprisingly inactive compared to then."

The worsening US fiscal deficit could also deliver a bombshell shock to global financial markets. As US Treasury issuance increases and issuance yields rise, global interest rates will also increase. The Federal Reserve's (Fed) monetary tightening could become ineffective.

Concerns about the Fed's independence infringement were also cited as a risk factor in Trump's second term. Regarding Trump’s repeated mentions during his candidacy of dismissing Fed Chair Jerome Powell, he said, "It is understood that Trump believes he can legally dismiss Powell," expressing concern that "The Fed's independence faces a serious challenge due to Trump's election." This points to a high likelihood of political logic interfering with monetary policy, which greatly affects the US and global financial markets. Contrary to Trump's criticism, Frankel evaluated the Fed's monetary policy as "appropriate." He said, "Many say the Fed raised rates too late and lowered them too late, but these are minor issues," adding, "There were external factors such as supply chain bottlenecks affecting inflation, and inflation declined due to the Fed's rate hikes and the resolution of supply chain instability. The Fed responded appropriately."

Regarding the outlook for the dollar's value after the start of Trump's second term, he said, "It is difficult to predict," while pointing out contradictions in Trump's policies. He said, "Trump's promised tax cuts and tariff hikes are factors that would increase the dollar's value," and "He says he wants a weak dollar but pursues policies that could lead to a strong dollar; I don't know if Trump is aware of this contradiction." Tariffs stimulate inflation, potentially prolonging the Fed's high-interest-rate stance, and tax cuts are also factors for rising interest rates. This is likely to push up the dollar's value. Professor Frankel said, "The recent strong dollar trend has continued because the US economic growth rate is higher than other countries and real interest rates are relatively high," adding that there are various macroeconomic variables, so "It is difficult to forecast the dollar's value trend at this time."

He evaluated the current US economic situation as "exceptionally good," stating that a soft landing has been achieved. He noted that the labor market and economic growth rate are unexpectedly robust, and inflation has fallen close to the Fed's target of 2%. He predicted the probability of a US recession next year to be 15%, the same as the average year. However, he pointed out that "Trump uncertainty" could be a major risk shaking the US economy.

Professor Frankel said, "During the COVID-19 pandemic, over one million deaths occurred in the US alone, but Trump denied it in the early stages of the pandemic, which ultimately caused great damage," adding, "The risk factor is that we do not know how he will respond to unexpected events. There are concerns about the impact of Trump's uncertainty and unpredictable policies on the economy."

About Professor Jeffrey Frankel

Professor Jeffrey Frankel is one of the leading macroeconomic experts in the US, well-versed in international finance and monetary and fiscal policy. He served on the President's Council of Economic Advisers at the White House during the Bill Clinton administration. He was a professor of economics at UC Berkeley. Currently, he is a professor at Harvard Kennedy School and a researcher at the National Bureau of Economic Research (NBER). He earned his PhD in economics from the Massachusetts Institute of Technology (MIT).