Tuesday, December 12, 2017

US Deficits in Goods Trade

Trade and protectionism are hot topics. At the root of the discussion is what has happened to the US as a trading partner. There is much to this debate and I won’t handle it all here today. Instead I focus on something that I think is central to the issue – the performance of US trade in goods.

International trade goes well beyond trade in goods. But as it turns out, a key part of what we consider to be problematic for the US is trade in goods. We trade services (like entertainment, transportation, shipping, and tourism) and we engage in a lot of international exchange with respect to financial and real assets (bonds, stocks, bank accounts) but we generally run surpluses in those trades. If we have a large and persistent trade deficit, it is mainly with respect to goods.

So I am back to playing with the data again this week. With trade figures there are choices to make. Much of what we refer to as trade is measured and captured in our balance of payments (BOP) account. There we find the Current Account and the Financial & Capital Accounts that contain information about exports, imports, and so on. These figures are always presented in nominal terms and thus measure changes in both quantity and price. Export and imports of goods and services are also published in our National Income Accounts (NIA) and those measures of trade are very compatible with the way Gross Domestic Product (GDP) is measured. The NIA accounts are presented in both real and nominal terms.

Yikes – too much information. Anyway, I decided to use the NIA measures since they are compatible with the way GDP is measured. I am using the nominal versions because they are somewhat more compatible with the BOP figures. I did a quick comparison of the real and nominal NIA measures and it didn’t change my overall conclusions. Whew. Where’s that JD?

The table at the bottom shows nominal NIA measures of US exports and imports of goods starting in 1964, the year I began studying Industrial Management at Georgia Tech and was introduced to chili dogs at the V in Atlanta. I present data for five years that are separated by 13 year-intervals because 13 is my favorite number (1964, 1977, 1990, 2003, and 2016). These 5 years bracket 1990 which is a demarcation point for the rise of globalization. This allows me to compare 26 pre-globalization years to 26 post-globalization years. Is this fun or what?

The top of the table presents US imports and exports in billions of dollars. Nominal GDP, also in the table, went from about $6 trillion in 1990 to almost $19 trillion in 2016. Some of that increase is because of price increases – with the rest from quantities. But GDP is not the point today – though it gives you a benchmark as to how much the size of the overall economy changed over those 52 years. Goods exports went from $403 billion in 1990 to almost $1.5 trillion in 2016. Imports increased too – from $508 billion to about $2.2 trillion. The net imports (imports minus exports) was $105 billion in 1990 and increased to $778 billion in 2016.

If I stopped right now many of you would have an aha moment. What you would see is the following post-globalization experience: US imports of goods outran our exports of goods and the trade deficit in goods increased dramatically. There are no smoke or mirrors here. This is the kind of information that supports the popular idea that globalization has not been good for the US and that there might be unfairness working against us – be it so-called free trade agreements or cheating or whatever.

But let’s not stop there. In the second part of the chart we display trade in goods as a percent of GDP. In 1964 goods exports were 3.9% of GDP. By 2016 goods exports accounted for twice the share of the economy at 7.8%. But notice that the pre-globalization gain of 2.8 percentage points (from 3.9% to 6.7% of GDP) compared to the 1.1 percentage point gain in the post-globalization years. That is, exports gained as a share of the economy much more before- compared to after-globalization. What about imports? Imports of goods increased 2.7 points before globalization and then 3.4 points post-globalization.

It is true that imports of goods picked up its pace after globalization while exports did the opposite. But notice also that much of those changes came in the 13 years after 1990. During the time from 1990 to 2003, exports fell as a share of GDP while imports rose dramatically. But then in the most recent 13 years we see that reversing as the share of exports increased at more that twice the pace of goods imports.

What can we say?

First, goods trade – both exports and imports were rising as a share of the economy for 52 years – both before and after globalization began accelerating in 1990.

Second, when we compare the data before 1990 with what happened afterward you can see much bigger increases in imports of goods relative to exports.

Third, if we look closer at the data since 1990 we see that most of the advantage of imported goods peaked by 2003 and has reversed since.

What does all this mean? For one thing it means that this is a pretty rich stew with a lot of vegetables. If we combine these numbers with the numbers from last week’s blog post we wonder if some of these trade results have something to do with the fact that so many countries have been narrowing the economic gaps between them and the US.

The 1990s were a time when many countries decided to open-up and use trade as a development tool. These countries wanted to rebuild and become more competitive and many were very successful as we saw in this blog last week. As incomes across the world grew, so did their appetites for goods and the growth of US exports of goods verifies this. But as their incomes grew they also became stronger competitors to the US and our goods imports rose as well.

Since so many countries were starting from very low incomes and poor productivity it made sense for the US to make special compensations or to ignore remaining protections in these countries. US citizens gained many of the benefits as more goods were available to them at lower prices. Lower prices gave US residents more dollars to spend and these people redirected some of these surpluses to US companies and created millions of jobs. The GDP data below show remarkable growth in our economy as some jobs declined while other expanded. 

There are some who think that the US can use its own arsenal of protectionist policies to preserve and restore jobs in the US. But that thinking is short-sighted. Despite catching up many countries still retain much lower incomes and a distinct price advantage that goes with it. Protecting US citizens from low prices on low-skilled goods makes no sense. It’s like sticking a finger in the dyke. What makes more sense is to recognize that the world has changed and that developing countries need to protect their own industries and workers less. Let’s not raise the worldwide level of protection – let’s lower it. 

But what about all those US workers in firms and industries that cannot compete? The answer is pretty simple in principle. Protecting these workers is only a temporary measure so long as the American worker makes $50k per year and foreign competitors make half or less. What makes sense is to encourage other countries to keep catching up with our incomes – and to find ways to better train and retrain our workers to fit better into US advantages in education, science, technology, entertainment, communications, and so on. The data below suggest that the export/import issue started turning in 2003. Perhaps we can keep that alive in the next 13 years following 2016.

Billions of Dollars
1964
1977
1990
2003
2016
Nominal GDP
        686
      2,086
      5,980
      11,511
      18,625
    Exports of Goods
          27
         128
         403
           741
        1,446
    Imports of Goods
          40
         153
         508
        1,296
        2,224
    Net Imports
          13
           24
         105
           555
           778
As  Percent of GDP
1964
1977
1990
2003
2016
    Exports of Goods
3.9
6.2
6.7
6.4
7.8
    Imports of  Goods
5.8
7.3
8.5
11.3
11.9
    Net Imports
1.9
1.2
1.8
4.8
4.2
Source BEA.gov



Tuesday, December 5, 2017

Catching Up to the USA 1990 to 2017

Happy December!

I had so much fun last week with data I decided to do even more this week. This time I have some tables to discuss and they need a little explaining. But first, a little background. The idea today is to shed some light on how much the world has changed in the last 28 years. My data starts in 1990 and looks at changes through 2017. The data come from the International Monetary Fund; it's their measure of real GDP per capita. RGDP per capita is one way to measure changes in the economic welfare of the average person.

This sort of cross-country comparison is not easy. I chose per capita real GDP because it seems closest to the buying power of people in these countries. Country comparisons usually require conversions of non-US currencies to the dollar so all the GDP figures below have been translated to dollars. It is traditional for longer-run comparisons to use an exchange rate called the purchasing power parity value of the exchange rate to the dollar. The IMF used the 2011 PPP value of the dollar for these comparisons. Yes, using PPP is highly debatable but I am sticking with it!

Much has happened in the world since 1990. The Soviet Union imploded, and the Berlin Wall came down. Globalization re-started. Many free trade agreements were consummated. The year 1990 was a time when the USA had a considerable lead on most countries in terms of economic size and competitiveness. Home Alone was the most popular film in 1990, and Windows 3 was released by Microsoft.

Table 1 lists 36 countries I selected to compare with the US. In 1990, real GDP per capita in the USA was nearly $37k. Right behind the USA in 1990 were Germany, Italy, Canada, France, and Japan. Saudi Arabia was ahead of all these countries with a value of $46k. Among those at the bottom in 1990 were two countries freed from the Soviet Union (Lithuania and Latvia) and three Asian countries (China, India, and Vietnam).

Table 2 measures the growth of real GDP per capita of these same countries between 1990 and 2017.  During that time period US per capital GDP increased to almost $54k and grew about 2.5 times. Twenty-two of these countries grew faster than the USA. But three stick out in the list for growing more than the rest, with China growing 10 times between 1990 and 2017. You might say that since the per capita real GDPs of those countries were small in 1990, they had the chance to grow faster and that would be true. But notice that not all of those countries with lower incomes in 1990 grew so fast. Obviously the speed demons had something special going on that helped assist the growth. Latvia and Estonia took advantage of the dissolution of the Soviet Union. Several Asian countries -- especially China, Vietnam, and India -- showed remarkable ability to change and grow.

Table 3 focuses on how fast this group of 24 is closing in on the per capita RGDP of the US. I did a double-take and then some research just to check the top line of Table 3 that shows Ireland's per capita real GDP was $66K in 2017. Ireland's value went from 60% of the US in 1990 to 120% in 2017. Now that is catching up! Where's the Irish whiskey? I am ready to drink to that. No offense intended to JD.

The order of countries in Table 3 is in terms of how much each country caught up to the US. Taiwan is second in the table because it went from 40% to 80% of US per capita RGDP. Countries that closed the gap on the US the most were Ireland, Taiwan, S. Korea, Lithuania, China, Latvia, Poland, Turkey, Vietnam, India and Israel.

Mexico is one of the countries that did not close the gap with the US. Mexico's per capita RGDP was about 30% of the US in 1990 and it remained at 30% in 2017. Canada's values were larger than Mexico's but Canada did not gain on the US either, remaining at about 80% of the US in 2017.

Some countries slid downward. For example, the bottom of the chart is taken by Saudi Arabia whose per capita RGDP was 120% of US in 1990 and fell to 90% in 2017. Other sliders were Italy, Venezuela, Greece, Japan Russia, France, S Africa, Brazil, Haiti, and Germany. Recall, the US grew by 2.5 times in those 28 years. These last countries grew slower than that.

There are many factors that contribute to a country's growth in real purchasing power. Today's blog post does not explain why some countries grew faster than others. But it does show quite a disparity in performance over a 28-year time period. We are not all the same in relative terms as we were when we watched Home Alone in 1990. These differences will reflect the bargaining positions and powers as trade and other relationships are fashioned in the years ahead. Understanding changes in economic power might be useful as we negotiate in the future.

Real GDP Per Capita (Purchasing Power Parity)
Source: IMF: World Economic Outlook Database October 2017

Table 1
Country 1990 2017
Argentina 11,225 18,844
Brazil 10,562 14,127
Canada 31,411 43,875
China 1,515 15,151
Colombia 7,523 13,174
Egypt 6,848 11,842
Estonia (1995) 11,003 28,684
Ethiopia 644 1,926
France 30,421 39,691
Germany 32,067 45,757
Greece 21,442 25,314
Grenada 7,210 13,470
Haiti 2,027 1,650
Hungary 17,015 26,348
India 1,802 6,538
Iran 11,571 18,255
Ireland 21,208 66,196
Israel 20,065 33,037
Italy 30,969 34,606
Japan 30,362 38,878
Korea 11,633 35,897
Latvia (1995) 8,298 24,873
Lithuania (1995) 9,307 29,105
Mexico 12,411 17,753
Poland 10,163 26,658
Puerto Rico 22,286 34,537
Russia 20,801 25,427
Saudi Arabia 45,643 50,365
South Africa 9,899 12,215
Spain 23,662 34,788
Taiwan 15,546 45,412
Turkey 10,834 24,109
UK 27,077 39,755
US 36,999 54,223
Venezuela 14,786 11,290
Vietnam 1,473 6,267

Table 2
Country 1990 2017 Change
China        1,515      15,151 10.0
Vietnam        1,473        6,267 4.3
India        1,802        6,538 3.6
Lithuania (1995)        9,307      29,105 3.1
Ireland      21,208      66,196 3.1
Korea      11,633      35,897 3.1
Latvia (1995)        8,298      24,873 3.0
Ethiopia           644        1,926 3.0
Taiwan      15,546      45,412 2.9
Poland      10,163      26,658 2.6
Estonia (1995)      11,003      28,684 2.6
Turkey      10,834      24,109 2.2
Grenada        7,210      13,470 1.9
Colombia        7,523      13,174 1.8
Egypt        6,848      11,842 1.7
Argentina      11,225      18,844 1.7
Israel      20,065      33,037 1.6
Iran      11,571      18,255 1.6
Puerto Rico      22,286      34,537 1.5
Hungary      17,015      26,348 1.5
Spain      23,662      34,788 1.5
UK      27,077      39,755 1.5
US     36,999      54,223 1.5
Mexico      12,411      17,753 1.4
Germany      32,067      45,757 1.4
Canada      31,411      43,875 1.4
Brazil      10,562      14,127 1.3
France      30,421      39,691 1.3
Japan      30,362      38,878 1.3
South Africa        9,899      12,215 1.2
Russia      20,801      25,427 1.2
Greece      21,442      25,314 1.2
Italy      30,969      34,606 1.1
Saudi Arabia      45,643      50,365 1.1
Haiti        2,027        1,650 0.8
Venezuela      14,786      11,290 0.8

Table 3
Country 1990 2017 Rel to US Rel to US Chg Rel
Ireland      21,208      66,196 0.6 1.2 0.65
Taiwan      15,546      45,412 0.4 0.8 0.42
Korea      11,633      35,897 0.3 0.7 0.35
Lithuania (1995)        9,307      29,105 0.3 0.5 0.29
China        1,515      15,151 0.0 0.3 0.24
Latvia (1995)        8,298      24,873 0.2 0.5 0.23
Estonia (1995)      11,003      28,684 0.3 0.5 0.23
Poland      10,163      26,658 0.3 0.5 0.22
Turkey      10,834      24,109 0.3 0.4 0.15
Vietnam        1,473        6,267 0.0 0.1 0.08
India        1,802        6,538 0.0 0.1 0.07
Israel      20,065      33,037 0.5 0.6 0.07
Grenada        7,210      13,470 0.2 0.2 0.05
Argentina      11,225      18,844 0.3 0.3 0.04
Colombia        7,523      13,174 0.2 0.2 0.04
Puerto Rico      22,286      34,537 0.6 0.6 0.03
Egypt        6,848      11,842 0.2 0.2 0.03
Hungary      17,015      26,348 0.5 0.5 0.03
Iran      11,571      18,255 0.3 0.3 0.02
Ethiopia           644        1,926 0.0 0.0 0.02
Spain      23,662      34,788 0.6 0.6 0.00
UK      27,077      39,755 0.7 0.7 0.00
US     36,999      54,223 1.0 1.0 0.00
Mexico      12,411      17,753 0.3 0.3 -0.01
Germany      32,067      45,757 0.9 0.8 -0.02
Haiti        2,027        1,650 0.1 0.0 -0.02
Brazil      10,562      14,127 0.3 0.3 -0.02
Canada      31,411      43,875 0.8 0.8 -0.04
South Africa        9,899      12,215 0.3 0.2 -0.04
France      30,421      39,691 0.8 0.7 -0.09
Russia      20,801      25,427 0.6 0.5 -0.09
Japan      30,362      38,878 0.8 0.7 -0.10
Greece      21,442      25,314 0.6 0.5 -0.11
Venezuela      14,786      11,290 0.4 0.2 -0.19
Italy      30,969      34,606 0.8 0.6 -0.20
Saudi Arabia      45,643      50,365 1.2 0.9 -0.30

Tuesday, November 28, 2017

Crowding-Out

After three weeks of writing about tax reform, I decided to give us all a little treat and go back to some data. Below is a graph I did with the help of my Uncle FRED -- the data/graphing service of the St. Louis Fed. That's FRED! https://fred.stlouisfed.org/

What I am attempting to do here is to shed a little light on the impacts of government on investment spending. One worry about tax reform today and government growth generally is something called "crowding-out". Crowding-out refers to the idea that the government and the private sector compete to borrow the nation's saving. If the government borrows a dollar from you, that leaves one dollar less for a private company to borrow. This competition for our saving sometimes crowds out or prevents companies from borrowing, or at least raises the cost of debt enough to curtail spending by companies. 

The chart below plots two data series for the last 56 years. The first, in blue, is annual changes in federal government spending in billions of dollars. The second line is changes in real gross private domestic investment. Real GPDI includes both business investment spending (on plant, equipment, and software) and residential investment. This is the red line.

Before I get into some of the numbers, it helps to put this endeavor in context. This exercise is illustrative and seeks to point out a possible negative connection between government spending and private investment spending. This relationship is admittedly complicated and no single factor ever explains changes in investment. So I am going to prove nothing here. One illustration of my challenge is that the times when investment spending falls the most is during recessions. And those are the times when government spending rises the most. A simple logical error would be to mistake correlation for causation. That is, during recessions government spending rises and investment falls, but this is not the result of crowding-out. It is simply the impacts of a recession on investment and government spending. I won't make that mistake here. 

It is interesting to look into history and see when it appears that weak investment spending was the result of crowding-out by government. This is not going to happen all the time. For one thing, government spending has its own cycles wherein it is sometimes rising, sometimes falling, sometimes rising a lot, sometimes rising a little. We would expect evidence of crowding-out only during in those times when government spending is rising rapidly.

Lots of ifs, ands, and buts. But I still think it is worth the effort. (And what else do I have to do?) Conservatives worry that today's impending tax reform is going to cause government deficits and higher government borrowing, and this will lead to crowding-out. Crowding-out is important. Investment spending is the key to future productivity and economic growth. After the 2008-09 recession, investment spending came roaring back, but you can see in the graph that since around 2012, the changes in real GPDI have decreased and went negative in 2016.

So let's look back so we can think about what might be ahead. The chart starts in 1960 and stretches to 2016. Notice the sharp negative impulses in real GPDI. The biggest decreases were during recessions so I won't discuss those further. What is pertinent for my purpose today are the following episodes:
  • After peaking in the mid-1960s, GPDI changes mostly declined through the rest of the decade as government growth was rising.
  • After peaking in the early 1970s, GPDI changes declined for several years as government spending changes rose.
  • In the late 1990s, government spending growth picked up as GPDI spending got smaller.
  • Starting around 2012, government spending increased each year while GPDI spending changes decreased and then turned negative. 
  • Finally, I looked hard at this data and can find no durable experiences when rising changes in government expenditures were accompanied by rising changes in GPDI. 
Sometimes government spending increases get smaller. A notable example is the several years starting from the early 1990s. It means the government got out of the way of firms that were trying to raise money in capital markets. That's what we call crowding-in.
  • Notice that government spending changes decrease from early 1990s for most of that decade and GPDI changes grew rapidly.
So whether you call it crowding-out or crowding-in, I find six examples that provide some evidence of the relationship between changes in government spending and investment spending. When government spending surges, it tends to limit how much investment can be purchased. When government spending increases decline -- something that does not happen very often -- this improves investment spending. 

Quite clearly, if we eliminate contaminated data surrounding the seven recessions from 1970 to 2016, we are removing much from our study. But focusing on those non-recessionary impacted years, we can see quite a few episodes of government crowding-out and crowding-in. 

Government spending soared after the 2001 recession and during the deeper recession of 2008-09. These increases declined for a while but the end of the chart shows government growing again. And current government spending proposals show no end in sight. The chart shows investment spending tanking as crowding-out would imply. 

Can we prove anything with this kind of analysis? I don't think so. But I think there is plenty of ammo in the data to suggest that if we want to see more national investment in housing, plant, equipment, and software, then we might give some consideration to putting a collar on government spending. My analysis did not examine tax cuts or tax reform that create needs for government borrowing. But I will go out on a limb and argue that any such increases in government borrowing because of lower tax revenues and higher government deficits will not be good for national investment either. Wouldn't it be interesting to be talking about government spending slowing and causing crowding-in!





Tuesday, November 21, 2017

The Tax Pizza

Happy Thanksgiving. I hope you are not having pizza for Thanksgiving!

Charlie, Pete, Diane, and Pat wanted to order a pizza. Charlie, of course, wanted tuna on it. Pete, a long-time lover of squid, voted for octopus. Diane favored brussels sprouts while Pat hoped for a nice sprinkling of calf liver. Eventually they compromised and decided to add all those ingredients together. Those of you who have not yet tossed your lunch will get my point. Compromise is not always a good thing. And that’s the way I feel about current tax legislation.

What seems to be missing in all the jockeying and the zillions of words vomited by the media these days is that tax change is done for many reasons. While one should expect that these reasons might conflict as much as liver and squid, it is not unreasonable that we should try to find a compromise. But it is also very possible that compromise will lead to a very bad tasting pizza.

Tax changes can be used for at least the following six reasons:
  1. Taxes might be raised to generate government budget surpluses to reduce the government's outstanding debt. This might also reduce the government’s footprint in financial markets and give more breathing room for firms to attract investors to their assets.
  2. Short-term spending management is part of the Keynesian approach to fine tuning the economy. We give tax breaks to people and firms in a recession so they will spend more. By design these tax changes are temporary and should not have lasting impacts on government debt.
  3. Taxes can be rearranged to create incentives. This need not impact the total amount of revenues collected – only their composition. Reducing taxes (by giving subsidies or deductions) can be useful to promote more work, saving, investment, baby-making, JD production, etc.
  4. Tax changes might be used to affect poverty or the distribution of income. Progressive taxation wherein wealthier people pay higher rates of taxation is part of that effort. But that is just the tip of the iceberg. It is possible to use the tax code to subsidize housing and feed the poor while limiting, say, how much mortgage interest a richer person might deduct.
  5. Taxes can also be used to absorb your time and subsidize the consulting industry. A tax code with many deductions, subsidies, and tax rates means you either spend a ton of time doing your taxes or you hire someone to do them for you.
  6. Taxes can be used to stimulate long-term economic growth. The way to do this usually involves creating incentives for more production. Note – this is VERY different from any of the above goals for tax changes. This one is meant to create an environment in a largely market-oriented economy for businesses to make more money. The idea is that when firms try to make more money they often need to hire more workers and raise their wages. Despite the fact that the immediate impacts of this kind of tax reform are aimed at higher income people and firms, we expect most people to benefit, though not equally.
Okay so that’s six toppings for the tax pizza. So what? If it isn’t already obvious, the main idea here is that we might want to prioritize our goals when it comes to the current tax debate. Putting all six toppings on the tax pizza will likely taste bad. At best, trying to serve six masters dilutes all of them and the end result is a lot of people who are unhappy they didn’t get their fair of the total benefit.

An alternative approach is to prioritize the goals. Of those six goals, which one or two are the very most important for the country today? I tend to harp on economic growth. But I have friends and neighbors who would rather see income distribution as the number one goal of tax change. I say let the political process work that out. While I might disagree with the outcome, at least we might get a policy with a clear intent to improve a difficult problem.

The problem is that our talking heads don’t want to create such a clear set of choices. They survive and profit through obfuscation. They think we are stupid or maybe too busy on our mobile phones to participate. Isn’t it sad that they might be right? Another slice of pizza for you?

Tuesday, November 14, 2017

Trickle Down Tax Policy

Last week I wrote about the Tower of Babel we call tax reform. The main point was the incredible lack of clarity when it comes to changing or reforming taxes. Given all the deductions and other special preferences and the many conflicting goals of tax change, it is very easy to never meet a tax change you ever liked. It is hard to see how legislative progress can be made and even with it, how it might have a discernible positive impact on the country.

But there is even more to the story that I came across in some remarks I read by critics under the rubric of “trickle down”. As an elderly gentleman, I try not to be offended by terms like trickle down, but as an economist I get annoyed when I hear people throwing those terms around. These words are the heart of an argument made by those who are primarily motivated by issues of distribution of income. Trickle down is vivid. A lovely flow of benefits come to the rich folks and by the time they are finished gorging themselves, a couple of drops trickle down to the poor. We could switch the analogy to a lovely and delicious cake consumed by royalty with nothing left but a few crumbs for everyone else. But whether it is a trickle of water or a few nasty crumbs, the point is the same. It is all about how any policy tilts the flow of income or benefits towards the rich. No matter what the intended impacts of the policy might be, all we hear about is trickle trickle trickle.

Common sense allows for the possibility that the true or full impact of a policy could differ from its initial incidence. Let’s suppose a professional team has always done poorly. Its players are paid commensurately. Then the owner decides to bid for a new quarterback. The immediate impact is the apparent unfairness as the new player makes much more money than the others. If the new QB is as good as heralded, the team will win the championship and all the players get bonuses and a big raise. The ultimate impact is what counts despite the apparent unfairness of the initial one. While it is true that these other players still earn considerably less than the handsome, young, sensation with TV contracts and important friends, they are making more than they did before and most would not vote to fire the new player.

Think about one of the many elements of tax reform – significantly reducing the rate of taxation on corporate profits. The immediate impact is easy to envision – a bunch of very rich company owners or stockholders in their condominiums in Vail smoking fine cigars and drinking Spanish brandy. While I cannot deny that owners of corporations will get richer, there is obviously more to the story. Think accounting. I was not a stellar accounting student in Professor Gamoneda’s class at Georgia Tech in 1966, but I do know that if you apply a smaller tax rate to a company’s profits, the company has some additional money to play with. What can that company do with that extra money afforded by the lower tax rate? Here are some examples in no particular order:

            Bribe a government official
            Give it to the owners
            Give it to the employees
            Give a new or improved benefit to employees 
            Add a new wing to the factory
            Buy new production equipment
            Buy new software
            Lower price to get a competitive advantage
            Give more to the local Boys and Girls Club
            Pay off debt faster
            Save it
            Give it to Larry

I am sure I missed something in that list but you get the point. It is tempting, and there might be times when giving most of the extra proceeds to the owners might make sense. But most companies have to compete, and it is pretty clear that they will spend a lot of money to gain an advantage over their adversaries. 

Though this list is long, keep in mind that if your concern is employees, many of those items in the list contain indirect impacts on the incomes of those employees. Any expense – whether it is to better train the employee or it gives that person better equipment to work with  should result in higher productivity. Higher productivity makes it easier for firms to pay them more.

The above can be extrapolated to any element of tax change. There is an immediate and obvious impact followed by less certain and/or less obvious ones. If a tax cut for a higher income person leads to more saving and lower interest rates, that might reduce what a middle income person pays to borrow for a house or a car. Maybe you want to call that trickle down. I just call it economics. To ignore these subsequent but undeniable impacts is folly. 

It is very bad economics to pretend that the only impacts of a tax change make rich people richer and poor people poorer. My advice for those of us who care about the income distribution and poverty is to quit harping on tax reform and spend a few minutes focusing on the real problems that prevent people from leaving poverty status. Or maybe that is too hard to do. If Lyndon Johnson were around and saw the results of his War on Poverty, he might wonder who won the war. 

Tuesday, November 7, 2017

Lesson 20 Taxes (Tower of Babel)

I am sitting at my desk reading all the articles about the latest proposal for tax change in the US. What a mess. Despite it being morning, it makes me want to reach for the extra-large bottle of JD. Have you ever tried JD on Honey Monster Puffs? Wow.

So I scratched my head hoping for some sort of stimulation in brain activity and decided it was time to start at ground zero with a lesson on taxes. Imagine us regular folks trying to decide the best route to Mars. I could begin by wondering about rocket fuel, sun spots, and billboards. And that might lead to discussions with neighbors and perhaps heated arguments, but the truth is that we amateurs might never converge on a realistic answer about the best way to get to Mars. There are so many issues! Better to argue about landscape issues.

So how does any of the above relate to taxes and recent tax proposals? The answer is that while the main idea of a tax is pretty simple, it is the use of taxes that makes the topic so complex. What is a tax? A tax is a way for the government to raise money so it can buy its citizens things. We take for granted that cities, states, and the nation should provide things to their citizens. 

Our Bloomington mayor wanted some shiny, new trash collection trucks so he added a new tax for that purpose. He already gets lots of our money for silly things like fire and police protection but he needed a wee bit more for these pretty new trucks. Each house got equally attractive new garbage cans that come in three sizes so it all made sense and none of us complained.

I think I already got off track. The main idea so far is that governments provide for their citizens, and they need money to do so. So they tax us. Taxes come in all shapes and sizes. In the USA, the main taxes the federal government collects are based on our incomes. State and local governments tend to tax incomes as well as goods we buy. Regardless of the source, these governments use the proceeds to take care of their citizens. That seems pretty simple. If the government wants to spend more, it has to tax more. So why are our friends in Washington, DC, so wild and crazy about the recent tax proposals? Have they been watching too many Steve Martin reruns? 

I can see at least three reasons beyond Steve Martin why the tax proposal generates so much commotion. First, the Federal government is allowed to go in debt. So we have a choice when we want to spend more. We can raise taxes or we can incur more debt or we can have a little more of both. Second, we not only raise most tax revenues based on income but we have a progressive tax system that charges higher rates on higher incomes. Third, the tax system is “holier” than Swiss cheese. No offense to Roger Federer implied. These holes are there for a purpose. Most of us are the recipients of at least one tiny little hole. For example, realtors love it when people can write-off the interest they pay when they borrow to buy their new tiny house. It makes it a lot easier to sell a house when the buyer is being subsidized. The same goes for electric cars and pain pills. Geez, how many of these so-called loopholes or deductions are there? Please don’t count them all up – you have better things to do today.

So what have we learned?  Taxes are pretty simple in principle but in practice they are more complicated than a mission to Mars. It is not simply a matter of government raising taxes so it can buy us shiny new garbage trucks. It becomes a series of questions about how every single person – dare I saw every voter – will react to any given specific way to raise those taxes.
            Tax increase or debt increase?
            Tax high-income people or low-income people?
            Tax young people or old people?
            Tax workers or retired people?
            Tax savers or spenders?
            Tax students or professors?
            Impact housing industry or stockbrokers?
            Tax heirs or new children?
            Tax sexy persons or economists?
            Should I go on?

If you answered yes to the last question, then you need help. If you thought the above stuff was fun, keep reading. It gets even more complicated. We blandly assumed that the tax increase is about raising the resources to spend more. But that is never the whole truth. We use the tax system to cure everything from male impotency to invasive Asian carp.

Think of all the hidden tunnels in our discussions today. Some of us want to use the tax change legislation to reform the tax code so it will create more growth. Others want to use it to address the distribution of income. Still others want to use it for short run stabilization of national spending. While all these goals are laudable, a tax change that improves growth might not immediately improve the distribution of income. A tax program that favors more short-term spending might damage sustainable economic growth. And of course, many of us worry about how these tax changes will affect the price of JD.

I am getting close to my word limit so I better sum up. I can do that with two words – Tower of Babel. Okay, that’s three words. That’s not many words compared to the number you will see and hear in the next days about tax reform. And I bet you this: Few if any of the authors of those words will explain what taxes are and what they should be used to accomplish. Each of these selfish people will take the easy road and will loudly point out how one group is to be favored over another. Having a realistic and thoughtful approach to taxes is beyond them. They would rather achieve star status by fussing about the low hanging fruit. Inasmuch, it is difficult to see any proposal that would have any beneficial impacts passed by the mental institution we call Congress. No one wants to be a loser, and no one will admit what goals they hope to accomplish. 

Even if a proposal is passed into law, we will accomplish no national goals, and we will end up pointing more fingers at each other after the tax change than we did before it.