During the campaign, neither Trump’s team nor Kamala Harris’ had much to say about public finance beyond the issues of tariffs and tax cuts. Neither candidate addressed the federal deficit or the bond market in a meaningful way. The closest they got to public finance was the way each side portrayed the benefits vs. the inflationary impact of COVID-19 recovery legislation, and neither campaign team made reference to state and local budget consequences. Inflation was the issue: Egg prices were more important than intergovernmental fiscal policy.
So while it remains to be seen as to what exactly the new political team in the White House will propose on Capitol Hill, it is pretty clear that the first orders of business will be to extend the 2017 tax cuts, push for lower corporate taxes for domestic manufacturers, fulfill some of candidate Trump’s promises for idiosyncratic tax exemptions and cut government spending. The big unknown, as explained below, will be whether there are enough votes in both houses of Congress to sustain the wild card of dramatic budget cuts of the magnitude ballyhooed by billionaire/influencer Elon Musk.
The omnibus tax bill is central to the entire process because Republicans have one shot on goal to push through a tectonic budget and tax bill with a simple majority in the Senate under the so-called Byrd rule, which allows a budget bill to bypass filibuster rules. Accordingly, the Super Bowl of Taxes in 2025 will be fought over all kinds of competing fiscal proposals that will require complete party loyalty to prevail. Even with majorities in both houses, GOP leaders run the risk of defections or stalemates if they go overboard on provisions that individual members simply cannot stomach or endure politically back home.
The White House transition team is not encumbered by such practicalities, and there is good reason to expect that some aggressive proposals may be sent over to the Hill, even if it’s just for show. For example, there is the long-lived ambition of many traditional pre-Trumpian Republicans, as well as those involved in the provocative Project 2025 blueprint, to eliminate the Department of Education, or at least sharply cut back its $238 billion budget, on grounds that it never deserved to be a cabinet agency. Either would have monumental impact on state and local school financing.
It's not yet obvious whether the votes will be there in Congress to do more than just make noisy symbolic cuts to the Education Department budget and attach sticky social-conservative strings to continuing federal aid. Congress can pass budgets and taxes with simple majorities, but it cannot create or disestablish entire agencies without 60 votes in the Senate. The same problem will face Musk and his budget-slashing teammate, pharmaceutical entrepreneur Vivek Ramaswamy, who will soon find that every dollar of spending has a constituency that will squawk vociferously when its goose is plucked: The color of their feathers will matter.
What won’t be for show is a “mandate” claimed by Trump and his GOP allies to trim government spending at as many levels as possible, and that will be the starting point for how federal budget policy will impact states and localities. That said, skeptics and fiscal historians will remind us of the many previous initiatives to overcome fiscal incrementalism with zero-based budgeting and other fanciful efforts that ultimately delivered very few enduring spending cuts. But it’s hardly paranoid now to anticipate renewed cutback proposals; discretionary intergovernmental grant programs in particular have a bull’s-eye on their backs.
Keep your eyes on the fate of the Impoundment Control Act of 1974, which could be revised if Republicans can muster enough votes to give the president unilateral powers to selectively curtail spending approved by Congress — effectively giving him a budgetary line-item veto. That would dramatically expand and amplify the president’s “power of the negative” to shrink programs and kill earmarks that often favor pet local projects and constituents.
Pushback from Capitol Hill
If there is a single theme that state and local policymakers should internalize now, it is the importance of fiscal self-reliance. Habitual lobbying in Congress for ever-growing federal intergovernmental largesse is likely to face stronger pushback in the coming regime than we have seen in decades. As I’ve suggested before, a logical corollary is the importance of properly funding state and local rainy-day budget stabilization funds in advance of the economy’s next cyclical recession on the assumption that there won’t be much help from Capitol Hill.
Democrats now hold a sour taste in their mouths from the inflation hangover from those COVID-19 recovery bills that they proudly touted back when they pushed them through in 2021. The returning president is keenly aware of the economic and political benefits of sending autographed stimulus checks directly to households instead of relying on traditional countercyclical federal spending and intergovernmental fiscal assistance. The traditional paternal advice is just as relevant to needful governors and mayors: “You’re on your own now, kids.”
Another candidate for major fiscal surgery could be Medicaid, the entitlement program with the least-organized political constituency and the largest budgetary impact on states. Don’t be surprised to see leaders in the next Congress come up with ways for states to opt out of certain benefits, essentially shortchanging their poorest citizens and especially recent immigrants. Blue-state liberals will feel compelled to make up the difference at local taxpayer expense — a politically risky move in this game of three-dimensional chess. County safety-net agencies sit on the front lines of this battle.
Markets’ Impact
The financial markets have both anticipated and reacted to the election results with a growing expectation that Trump’s tariffs and any new or renewed tax cuts could result in continued or even larger federal budget deficits and potential price inflation. That’s good news for sales tax receipts but bad news for homebuyers, and it potentially puts a lid on property tax increases if mortgage rates, which price off of U.S. bonds, stay stuck at high levels. Yields on long-term Treasury bonds have increased by more than half a percentage point in the last two months. That pushed up the interest rates on newly issued municipal bonds, which jacks up the cost of infrastructure funding for states and municipalities.
For public treasurers and cash managers, the money market has also adjusted its structure for interest rates on paper maturing next year, with traders now projecting somewhat higher short-term rates in 2025 than they had anticipated even just two months ago. Although the Federal Reserve recently cut its overnight rate another quarter-point and is expected to continue intermittently with a few more cuts by next summer, there is now less market conviction that short rates can drop much below 4 percent, barring a recession. Nonetheless, that will result in a slightly positive-sloped “normal yield curve” emerging midyear in 2025, at which point most state investment pools could eventually regain their popularity with municipal investors by capturing slightly longer-term rates than overnight cash instruments while offering the same liquidity. If Fed funds rates do fall materially below 4 percent next year, expect more local treasurers to dive back into those state-overseen pools.
For public pension funds, the silver lining is that the stock market has reacted favorably to the Trump team’s promise of less government regulation of big business, a protectionist trade policy and lower corporate tax rates. Along with the benefits of a growing economy — ironically delivered to us by the lame-duck Biden administration — the broad stock market has now gained over 45 percent in prices in the last two years, and that will reduce unfunded pension liabilities significantly for many plans. Even without changing their actuarial assumptions, this resulting lower unfunded actuarial accrued liability will mathematically reduce many employer contribution rates as much as one-half to 1 percent of payroll in upcoming years, depending on their actuarial and fiscal calendars, portfolio mix, participant demographics and performance history. Most systems will still not be fully funded, but they will feel and look healthier on paper as we enter 2025.
Wild Cards
As noted previously, the exact nature and scope of Elon Musk’s “kitchen sink” budget-cutting strategies is yet unknown, but he’s talking big bucks — in the trillions. Whether and which specific proposals erupting from the brain of the world’s richest bro could actually clear the next Congress, given its thin voting majorities, is yet to be seen. What is clear is that any intergovernmental spending program that lacks a prominent state or municipal constituency friendly to the new regime could be on the block for budget-cutting proposals.
Simultaneously, the next tax bill could also include an extension of the 2017 tax breaks for opportunity zones in some form, despite their reputation as havens for crony capitalism. Given the president-elect’s personal history as a real estate developer, don’t be surprised if that platter of tax breaks is given a lifeline to promote yet more construction projects. It’s too soon to guess whether investors’ suggested reforms to promote more small-business startups will make it into new law.
Budget-meisters in the new political order may also take a look at the long-standing exemption of many state and local pension systems from the Social Security system. Five million lucky public employees presently enjoy a free exclusion from taxes to fund the federal old-age income subsidies of poverty-level retirees and get to pocket their “equivalent” contributions for themselves. One idea is to require participation in Social Security by all new state and local government employees, which would increase federal tax receipts in the short term while adding to long-term liabilities that come due in a distant future after today’s incumbent office-holders are long gone.
Only time will tell which of these possibilities actually evolve into serious legislative proposals after the 2025 inauguration. But this sketch of possible landscape background features should give state and local officials and their financial staffs plenty to ponder — and watch out for. Don’t be surprised if some make it into law.
Governing's opinion columns reflect the views of their authors and not necessarily those of Governing's editors or management. Nothing herein should be construed as investment advice.
