The promise that tax cuts will pay for themselves by firing up economic growth and filling the government's coffers, a staple of Republican politics since the Reagan era, is back, now coated in a layer of artificial intelligence optimism. Treasury secretary Scott Bessent is relying on an AI-laced economy to deliver annual growth of 3%, a rate achieved only twice this century outside the Covid rebound. President Donald Trump has echoed this fantasy, claiming the government can "take care of the 40 trillion" in federal debt "over a period of time" because "we're growing at a faster rate than we've ever grown before."
Markets Skeptical as Bond Yields Surge
Financial markets are not buying the promise. Last week, the yield on the 10-year treasury bond surged to its highest in almost a quarter century, more than a full percentage point higher than when Trump launched his trade war against Iran. The inflationary impact of that war is the most immediate cause of rising bond yields, already prompting the Federal Reserve to raise short-term interest rates. But the treasury market is also being hit by the US's unbalanced finances, with investors demanding more to cover the growing funding gap.
Budget Deficit and Debt Spiral
Borrowing is likely to become more expensive still. Foreign central banks have cut back on their exposure to US government debt, leaving the treasury reliant on private investors, who are also competing with AI companies borrowing heavily to fund datacenter buildouts. The US's finances are in a negative spiral, as rising bond yields put additional pressure on the budget. Interest payments on the federal debt alone consume 3.3% of GDP, up from an average of 2.1% over the preceding 50 years.
Trump's fiscal management is not helping. His One Big Beautiful Bill Act is estimated to add $4.7tn to the federal debt through 2035. The deficit already hit 6% of GDP, twice the size Bessent once promised, and the Congressional Budget Office projected it will close in on 7% of GDP by 2033, before Trump promised a $5,000 "dividend" to every US adult if the GOP kept control of Congress in the midterms.
Unrealistic Growth Scenarios
The Committee for a Responsible Federal Budget (CRFB) sketched out scenarios: assuming temporary tax cuts become permanent and lost tariff revenue is not recovered, achieving a 3% of GDP budget deficit by 2036 would require annual growth of 4.4% over the next decade. A balanced budget would require 7.2% per year. While some economists contemplate AI boosting growth to 15% per year, stabilizing the federal debt would require average total factor productivity growth of 2.5% per year over the next decade, a rate the US has only hit once since 1959.
Even if AI supercharged the economy, its impact on government finances would be muted, as it would shift growth from labor to capital, and the tax rate on capital is only about half the tax rate on labor. The massive debt-fuelled AI investments are pushing interest rates higher, complicating government financing. Stanford economist Hanno Lustig estimates datacenter owners would need revenue to grow by 45% annually for seven years to break even on investments estimated at $1.43tn this year. A similar analysis by Jared Bernstein and Stanford economist Ryan Cummings concluded the nation's six superscalers—Google, Meta, Microsoft, Oracle, SpaceX and Amazon—would need additional revenues of $13.1tn to $18.7tn over the next 10 years just to pay for their AI investments, roughly the same as their total revenues over the last 10 years.
Missing these targets could complicate the task of trimming the budget deficit and financing the US's vast public debt.
