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Are the Trump tax cuts justified?

5 Dec

There are two reasons to cut taxes. Keynesian tax cuts prime economic growth by increasing consumer spending power. This requires that government spending remain at current or increasing levels, thus expanding the budget deficit. Current estimates suggest that the proposed tax cuts will increase this deficit by more than a trillion dollars. GOP leaders are channeling Keynes to say that the economy will grow by enough to reduce the deficit in the unforeseeable future.

However, government borrows to finance deficits. If the promised economic growth happens, continued deficits require the government to compete with private investors for loans. This raises interest rates and therefore reduces investment and economic growth. Thus, cutting taxes when the economy is growing is a bad idea – unless the country as a whole can borrow cheaply from foreigners. But that caveat REQUIRES a capital account surplus and therefore a trade deficit. Thus, a Keynesian tax cut designed to “grow” the economy out of a deficit will have precisely the opposite effect if enacted when the economy is booming. It therefore seems to be a bad time for a Keynesian tax cut given that President Trump and the GOP are taking credit for a booming economy AND have signaled a desire to cut our current capital account surplus by reducing the trade deficit.

Alternatively, the GOP could plausibly justify tax cuts (and has in a more principled past) as a way to reduce government’s ability to transfer wealth from one group to another. This approach requires government spending to be cut as well since the purpose is to let the private sector be the engine of economic growth. This approach therefore reduces the size of the budget deficit. That ain’t happening!

The GOP’s tax cut justifications make no economic sense. The GOP has no economic credibility left.


“Border Adjustments” Tariffs Whatever

19 Feb

I do not understand why Mr. Trump and his GOP want to raise taxes on the American people.

Mr. Trump wants to hike import tariffs. His congressional Republican lackeys call it a “border adjustment.” Either way this tax will make goods and services more expensive for American consumers while their touted “benefits” are murky.

For example, a fall in the trade deficit is touted as one such “benefit”. However, this fall will ALWAYS be balanced by a fall in foreign capital investment in the US. Thats just how national income accounting works. Well that’s also fewer American jobs.

Another effect might be a devaluation of the US dollar because of a fall in demand for US assets. That makes our exports more competitive while making imports more expensive. Since many of the goods we make in the US have foreign inputs the net effect of all of this on American jobs and wages is murky.  Moreover, a fall in demand for US assets like T bills puts upward pressure on interest rates. Higher interest rates translate into less US capital investment and fewer American jobs. These higher interest rates could be neutralized by asset purchases by the Fed. But that could end up being inflationary.

Supporters of the “Border adjustment” claim that any inequity in the border adjustment will be negated by a rise in the value of the dollar. Well thats not so certain given the possibility I raise above. In fact anyone who claims they know exactly what will happen to exchange rates is at best wildly optimistic!

Advocates also keep talking about the border adjustment as “trade neutral”. Thats a lie. The whole argument for the border adjustment is that it helps import substitute and export industries while penalizing American businesses which use imported inputs. In fact even advocates say that prices of all goods will rise (see Which of course it would! In other words it is a tax on the American people.

Of course, US tariff increases will be matched by other countries. This trade war will impoverish everyone.

Not so long ago Republicans understood that government intervention in business decisions was a bad idea because the economy is complicated. As a result, policies have complex and often unintended effects. This was one argument for small government that did not promote grandiose policies with ever cascading unintended consequences. Republicans need to remember that idea. Executive orders or even legislation cannot repeal economics.

How about a flat destination based corporate income tax without any border adjustment? That would encourage American businesses to relocate to the US. It would increase demand for American goods and American workers. And all without the inevitable price hikes from so called “border adjustments.”

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