Will the OBBBA Tax Cuts Grow the US Economy?

The US economy is on a tear lately, boosted by the One Big Beautiful Bill Act’s (OBBBA) income taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. cuts signed into law in July but undercut by the administration’s erratic and punitive tariffTariffs are taxes imposed by one country on goods imported from another country. Tariffs are trade barriers that raise prices, reduce available quantities of goods and services for US businesses and consumers, and create an economic burden on foreign exporters. policy. While the net effect is positive, it appears much of the economy’s surprising strength over the last year and in recent forecasts is coming from the boom in artificial intelligence (AI). Over the long run, OBBBA’s permanent extension of lower marginal tax rates on work, saving, and investment lays a solid foundation for stronger economic growth.

The economy has substantially outperformed most forecasters expectations over the last year, with real GDP growth averaging 2.5 percent in the first three quarters of 2025 versus 2.0 percent in the baseline projection provided by the Congressional Budget Office (CBO) at the beginning of the Trump administration. The Atlanta Federal Reserve Bank currently estimates real GDP in the fourth quarter of 2025 will hit 5.3 percent, which (if it holds) would result in an average growth rate of 3.2 percent for 2025 compared to CBO’s forecast of 1.9 percent. Many economists attribute this outperformance in large part to AI, including capital expenditures on data centers, as well as a wealth effect from a rising stock market leading to higher consumer spending. For instance, Barclays estimates that about half of growth in output in the first half of 2025 came from AI spending.

Forecasts for 2026 are also looking up. In the December meeting of the Federal Reserve’s Federal Open Market Committee, the median forecast for real GDP growth in 2026 was 2.3 percent, up from 1.8 percent in September’s meeting and 1.7 percent projected for 2025. This comes close to matching CBO’s latest forecast (released January 8th) of 2.2 percent growth in 2026, up from 1.8 percent in CBO’s estimate from a year ago. CBO expects growth to taper in both 2027 and 2028 to 1.8 percent annually.

CBO notes that OBBBA “spurs additional economic activity” in 2026 that is “partially offset by the effects of higher tariffs, which continue to weigh on trade flows and economic growth, and by changes in immigration policy that slow labor force growth.” In 2027 and 2028, “growth is supported by increases in the labor supply and in investment that result from the 2025 reconciliation act and by the positive effects on productivity stemming from the adoption of generative artificial intelligence. Those factors are offset by other forces, including the fading of the reconciliation act’s boost to aggregate demand and the slower growth in the labor force due to reduced net immigration.”

Our modeling of the economic effects of OBBBA and the Trump tariffs are consistent with CBO’s analysis. We estimate that OBBBA will boost GDP by 1.2 percent in 2026, 1.4 percent in 2027, and 1.5 percent in 2028, before trailing off to an increase of 1.2 percent over the long run. The initial surge is due to temporary tax cuts that expire over the next four years, including tax deductions for overtime and tipped income as well as expensing for factories and other buildings used in manufacturing and production. OBBBA boosts growth over the long run primarily by extending the expiring provisions of the Tax Cuts and Jobs Act (TCJA), including lower income tax rates across five of the seven tax bracketsA tax bracket is the range of incomes taxed at given rates, which typically differ depending on filing status. In a progressive individual or corporate income tax system, rates rise as income increases. There are seven federal individual income tax brackets; the federal corporate income tax system is flat., expensing for short-lived assets (bonus depreciationDepreciation is a measurement of the “useful life” of a business asset, such as machinery or a factory, to determine the multiyear period over which the cost of that asset can be deducted from taxable income. Instead of allowing businesses to deduct the cost of investments immediately (i.e., full expensing), depreciation requires deductions to be taken over time, reducing their value and disco) and domestic research and development, and the pass-through businessA pass-through business is a sole proprietorship, partnership, or S corporation that is not subject to the corporate income tax; instead, this business reports its income on the individual income tax returns of the owners and is taxed at individual income tax rates. deduction.

These are supply-side effects that boost labor and capital, resulting in a 0.7 percent increase in the capital stock, a 0.4 percent increase in wages, and a rise in hours worked equivalent to 938,000 full-time jobs. It does not reflect any increase in aggregate demand that may arise from “putting more cash in people’s pockets,” such as through higher tax refunds, which many analysts emphasize.

The effect of the new tax cuts will be muted to the extent taxpayers are uncertain about how the new rules work. While the Treasury Department and Internal Revenue Service continue to issue guidance, there remains a lack of clarity on some of the key provisions that went into effect in 2025. For instance, taxpayers still await Treasury guidance on the new expensing provision for structures used in manufacturing and production, where there is ambiguity about which assets and which activities qualify.

OBBBA’s positive economic impacts are substantially offset by the Trump administration’s ever-evolving tariff policy. Assuming the current tariff policy remains in place, we estimate it will reduce GDP by 0.5 percent over the long run, shrink the capital stock by 0.4 percent and eliminate 503,000 full-time equivalent jobs. Accounting for retaliation by other countries—which thus far has been less than most anticipated—further reduces long-run GDP by 0.2 percent. The full brunt of the tariffs has not yet taken effect, as importers and other businesses have relied on un-tariffed inventory and delayed price adjustments to account for the higher costs. Furthermore, the policy remains highly uncertain as taxpayers await a Supreme Court ruling on the legality of the tariffs imposed under the International Emergency Economic Powers Act.

As discussed in an earlier post, the tariffs also offset about half of the fiscal cost of OBBBA. However, even if the current tariffs remain in place, debt as a share of GDP will reach a record high by 2028 and continue growing indefinitely, reaching 120 percent of GDP by 2034 versus 117 percent under CBO’s pre-OBBBA baseline. The unsustainable debt trajectory represents the greatest threat to sustained economic growth and by worsening the fiscal outlook OBBBA adds risk to the economic outlook, increasing the potential for higher interest rates, higher inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spendin, or abrupt policy adjustments.

Tax policy developments over the last year have been dramatic, to say the least, but the offsetting effects of OBBBA and tariffs make the net effects on the economy and the fisc less consequential in aggregate. The permanent features of OBBBA, primarily the extension of TCJA’s pro-growth tax cuts, put the economy on a sound footing. It remains a major challenge for lawmakers to address the unsustainable fiscal trajectory while maintaining or improving the ability of the tax code to support economic growth over the long run.