U-M forecast: Wider deficits spur continued economic growth in US, Michigan despite high uncertainty

Rising tariffs on Chinese imports and tax cuts for corporations and individuals are expected in the years ahead, though the revenue increases from the first are unlikely to offset revenue losses generated by the second, according to University of Michigan economists.

That could lead to slowing revenue growth and spiking federal deficits, the economists say in their annual U.S. economic forecast, released Thursday at the university's 72nd annual Economic Outlook Conference.

The economic study comes in the wake of a presidential election that's expected to spur significant changes in U.S. economic policies and posture in the world.

The recent election that brought victory to Donald Trump and Republican majorities in the U.S. Senate and House most likely means a continuation of tax cuts enacted during Trump's first term and a sharp rise in tariffs on imports from China that would take effect by 2026.

Revenue growth is expected to slow by that time, and the federal deficit is likely to climb to levels "unprecedented outside of wars, the recent pandemic and severe recessions," the economists say in the study.

Specifically, the economists say, they expect about $200 billion in tax cuts by 2026, partly counteracted by roughly $85 billion in new tariff revenue. They project the stimulative effects of the tax cuts will dominate the drag from the tariffs, causing the growth of real gross domestic product-the inflation-adjusted value of everything produced in a country-to speed up in 2026. But that comes at the cost of a wider federal fiscal deficit and a permanent 0.2% increase in consumer prices due to the new tariffs.

The report also forecasts the following:

• Real GDP growth should slow from a pace of 2.4% from the end of 2023 to the end of 2024 to 1.9% from then to the end of 2025. Looser monetary policy is expected to work through the economy sufficiently to lift quarterly growth to a 2.1% pace in the second half of 2025 and, as personal income tax cuts kick in, the quarterly pace of growth ramps up to an annualized rate of 2.5% by the end of 2026.
• The unemployment rate ticks up from 4.2% in the final quarter of this year to 4.3% in the first quarter of next, then stabilizes at 4.4% for the remainder of 2025 before declining back to 4.2% by the end of 2026.
• Inflation in the Personal Consumption Expenditures Price Index, the Federal Reserve's preferred measure, is expected to pick up briefly to 2.4% year over year this quarter as energy price decreases slow. PCE inflation then resumes its downward trend toward 2.1% at the end of next year, and accelerates to 2.3% by end of 2026 as the projected tariffs work their way through domestic prices.
• Private sector job gains continue to slow through the third quarter of next year, with job growth expected to pick up again in 2026. The government sector adds jobs throughout the forecast, albeit at a slower pace than 2023 as local government employment tops its pre-pandemic count.

The economists say there is a high level of economic uncertainty in the months and years ahead, including sudden changes in key economic trends, global commodity price volatility and the paths of ongoing wars.

Risks and uncertainty also run through the economists' forecast for the Michigan economy over the next two years. Although some changes could benefit the state, the expected increase in tariffs poses risks to its trade-dependent economy.

Ultimately, they say, the impact of tariffs on the local manufacturing sector likely will hinge on the extent of retaliation from U.S. and Michigan trading partners.

The economists believe the underlying cause of Michigan's labor market slowdown is its sensitivity to higher interest rates. Consequently, they project the state will return to growth-a boost in payroll jobs and a slight decrease in unemployment-over the next two years as easier monetary policy and another round of tax cuts boost medium-term growth.

"Although we acknowledge the very real risks of economic disruption ahead, we believe the most likely outcome is a state economy that withstands these challenges over the next two years, with moderate job growth accompanied by relatively low unemployment, tolerable inflation and rising real incomes," the economists said in the report.

"The U.S. economy has gone through times of great uncertainty before and emerged intact. We are projecting that both Michigan and the nation will follow that path over the next two years."