Tariffs may narrow US budget deficit in 2025, but recession risk looms: Fitch

The sharp increase in U.S. tariff revenues following the April 2 policy announcement could help narrow the federal budget deficit in 2025, but the longer-term fiscal benefit is likely to be limited by slower economic growth and additional tax cuts, Fitch Ratings said in a report released Tuesday.

The U.S. effective tariff rate (ETR) is projected to climb to around 25%, significantly higher than the 18% assumed in Fitch’s March 2025 Global Economic Outlook and up from just 2.4% in 2024. The revised estimate suggests potential revenues of up to $800 billion — or about 2.5% of GDP — if import volumes remain steady.

Even with slightly lower trade volumes, Fitch said the tariff revenue will have a “meaningful” impact on the 2025 budget. The ratings agency had already forecast the general government deficit to shrink to 7.1% of GDP from 8.1% in 2024, thanks in part to earlier tariff measures and the carryover effects of robust GDP growth and strong financial markets.

However, the agency warned that while the immediate fiscal injection appears promising, the broader economic implications raise red flags. “We believe the tariffs significantly raise U.S. recession risks and constrain the Federal Reserve’s ability to lower interest rates,” Fitch said, citing inflationary pressures and weakening consumer sentiment.

U.S. consumer spending growth slowed notably in the first two months of the year, and financial market volatility has added further pressure. Fitch warned that these risks, along with increased automatic stabilizer spending, could dampen non-tariff revenue streams by 2026 and beyond.

Fitch also assumes that the increased tariff income may be offset by proposed tax cuts. The Trump administration is considering extending and expanding the 2017 Tax Cuts and Jobs Act, with new proposals including further corporate tax reductions and exemptions for overtime pay, social security benefits for retirees, and tips. Discussions are also underway about lifting state and local tax deduction caps.

Efforts to reduce spending may prove insufficient to significantly alter the debt trajectory. Cuts to the federal workforce may bring modest savings, but civil service wages and benefits account for less than 5% of total spending. For the first five months of FY25, social security accounted for 21% of federal expenditures, followed by Medicare (15%), and defense, health, and net interest (each at 13%).

Meanwhile, the federal deficit reached $1.15 trillion in the first five months of FY25 — already closing in on the $1.83 trillion full-year deficit for FY24.

Despite pressure from some Republicans to match tax cuts with spending reductions, others are exploring procedural avenues to classify the extension of the TCJA as “current policy”, potentially sidestepping the need for offsetting cuts — a move staunchly opposed by Democrats.

Fitch warned that under its base-case scenario, the U.S. general government debt-to-GDP ratio would remain little changed, approaching 120% — more than twice the median for ‘AA’-rated sovereigns. “Rising debt remains one of the key sensitivities of the U.S. ‘AA+’/Stable rating,” the agency said.

With Congress still relying on continuing resolutions to fund the government through FY25, budgetary dysfunction could complicate a debt ceiling resolution this summer. Fitch noted that while a shutdown has been averted for now, the Congressional Budget Office estimates that the “X-date” — when the Treasury would run out of extraordinary measures — could fall in August or September.