Morgan Stanley
Wealth Management

Tax Cut Costs May Outweigh Benefits

Mar 19, 2025

Proposed tax and spending cuts from Washington pose risks to the economic outlook. Should investors brace for more market turmoil?

Author
Lisa Shalett
Lisa Shalett

Key Takeaways

  • Soaring policy uncertainty is roiling markets, with the S&P 500 Index having entered correction territory last week.
  • Proposed tax and spending cuts may stoke further uncertainty by adding to the U.S. debt load and failing to stimulate much growth. 
  • Tariff revenue projections may be overly optimistic, failing to account for potential retaliatory measures and lower import volumes.
  • Investors should consider looking for stocks with stable growth and diversifying across global regions to help mitigate risks.

The S&P 500 Index was recently hovering around a correction of 10% from its recent high. Disappointing economic data, the Federal Reserve’s pause in interest rate cuts and, more recently, investors’ soaring uncertainty around U.S. government policy are driving much of the market turmoil. Investing and consumer spending rely on confidence in the economy, and that confidence has been deeply shaken.

 

This dynamic has led many forecasters, including Morgan Stanley Research, to cut their real gross domestic product (GDP) growth estimates for this year and next. Importantly, with tariff concerns boosting expectations for higher inflation, the odds of “stagflation”—in which growth slows and inflation heats up—are rising, which can spell trouble for stocks and bonds. At this point, for many investors, a resumption of the bull market rides on a pivot in Washington’s agenda from tariffs to tax cuts and deregulation.

 

Morgan Stanley’s Global Investment Committee is certainly encouraged by the possibility that deregulation could support growth in sectors like financials and energy. However, we are skeptical that tax cuts and fiscal reform will significantly stimulate economic growth or improve the U.S. debt outlook. Several reasons underpin this skepticism and suggest that more uncertainty and market turbulence may be ahead.  

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      5:11
      Wealth Management

      Ways and Means

      Soaring policy uncertainty has shaken investor confidence. Will tax cuts help reinstate the bull case? There’s reason to be cautious. Learn why, and where investors may find opportunity amid volatility.

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      1. 1
        Budget plans fail to significantly improve the U.S. debt outlook.

        The recent budget blueprint from the GOP-controlled House of Representatives proposes an extension of President Trump’s expiring 2017 tax law for the next decade at a cost of up to $4.5 trillion, while also calling for $1.5 trillion to $2 trillion in spending cuts. However, achieving these cuts is politically challenging, especially given the thin majority in the House and the popularity of programs like Medicaid and Medicare, which are significant targets for these cuts. Even in the best-case scenario, the proposed cuts would only slightly dent the 10-year U.S. debt and deficit forecast, potentially increasing federal debt by about $2.8 trillion and adding $600 billion in annual interest costs. Federal debt and deficits are already outsized, and their continued growth could lead to higher interest rates that may weigh on economic activity and asset prices.

      2. 2
        Tax cuts’ economic benefits may not offset the costs.

        Many investors believe growth will come from the prospect of new measures, like lifting the $10,000 cap on state and local tax (SALT) deductions and eliminating taxes on tips or overtime pay. Here, the problem is not simply the sheer cost of these proposals but also the Congressional requirement that they, too, be paid for. Proposals to claw back money from the Biden-era CHIPS, Infrastructure and Inflation Reduction acts, for example, could have adverse impacts given the high level of economic activity such programs generate for each dollar of fiscal stimulus. These potential negatives are unlikely to be offset by positive effects from tax cuts for higher-income households and corporations, which tend to save and invest more than they spend.

      3. 3
        Tariffs may not increase revenue as much as expected.

        Estimates suggest that 25% tariffs on Mexico and Canada and an additional 10% on China, if fully implemented, could raise about $120 billion in a year for the government. That is a significant number, but there are reasons to doubt that revenues would be that large. For one, we have seen President Trump’s willingness to make changes and exceptions. Furthermore, 50% of imports from Canada and Mexico are expected to be deemed compliant with the United States-Mexico-Canada Agreement (USMCA) and not be subject to recently announced tariffs. Most importantly, these gross estimates of revenues from tariffs don’t account for the negative impacts of retaliation, the substitution of alternative products or potentially weaker import volumes.

      Next Moves for Investors

      Considering all this, markets are likely to remain volatile and idiosyncratic. Risk management is paramount.

       

      In this environment, investors should consider being opportunistic and adding stocks of companies that have shown stable growth, in sectors such as software, health care, consumer services and cyclicals like financials.

       

      Also continue to diversify regionally across emerging markets, Japan and select European names, using funding from long-duration rates.

       

      This article is based on Lisa Shalett’s Global Investment Committee Weekly report from March 17, 2025, “Ways and Means.” Ask your Morgan Stanley Financial Advisor for a copy. Listen to the audiocast based on this report. 

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