Tag: deficit

Weighing Trump’s Trade Apologists

In the wake of the recent “trade agreement” between President Trump and EU Commission President Jean Claude Juncker, we have seen a surfeit of commentary heaping praise on the U.S. president for his strategic trade policy vision and tactical brilliance. Much of that praise has come from people who share the president’s flat-earth view that trade is a zero-sum game played by national governments where the objective is to promote exports, block imports, and secure a trade surplus. Trump throwing U.S. weight around to assert the rule of power over the rule of law is music to this crowd’s ears.

But then there are the apologists who know better; the enablers. They are the bigger problem. In their obsequious tones, they explain how our brilliant president is blazing his own path toward free trade and that the evidence of his success is all around us. If we just disregarded Trump’s nationalist rhetoric, ignored his belief that the trade deficit means the United States is getting ripped off, shoveled away his mounting pile of destructive, protectionist actions, and stopped believing our own lying eyes, we too would rejoice in the greatness of a man who is committed—above all else and above all others—to free trade. 

Engaging in such extreme mental contortions is no easy task, but that’s exactly what an op-ed by tax reform luminaries Steve Moore, Art Laffer, and Steve Forbes in the New York Times last week expects readers to do.

Moore, Laffer, and Forbes (MLF) portray Trump’s “gunboat diplomacy” (you open your markets fully or I’ll close ours!) as strategic genius, akin to Reagan’s nuclear arms race, which broke the Soviets’ backs.  They conclude: “Just as no one ever thought Mr. Reagan would stem nuclear proliferation, if Mr. Trump aggressively pursues this policy, he could build a legacy as the president who expanded world commerce and economic freedom by ending trade barriers rather than erecting them.” Well, yeah, maybe he could.  But so far Trump has only increased trade barriers, more are coming, and there are no negotiations underway—with anyone—aimed at lowering tariffs or other barriers to trade.  But just close your eyes and imagine.

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US Only Country With Projected Rising Government Debt to GDP Ratio Through 2023

Where government debt is concerned, advanced economies should be fixing the roof while the sun shines. That’s the central message of a new IMF Fiscal Monitor entitled “Capitalizing on Good Times.”

The paper entails projections based on growth forecasts and budget plans of what will happen to deficits and debt across advanced economies. And the results for the United States are not pretty. In fact, as the chart below shows, the US is now the only advanced country projected to see a rising debt-to-GDP ratio in the coming 5 years.1

Debt to GDP

Now we have to take all this with a pinch of salt of course. For advanced economies as a whole the IMF says “the fiscal stance is expected to be mildly expansionary in 2018 and 2019, followed by gradual adjustment in outer years”. I’ll believe that when I see it. Governments around the world have a tendency to plan to be fiscally responsible in a few years’ time, without eventually delivering, and to be overoptimistic about their growth prospects (many of which, it’s worth noting, are much, much worse than the US).

But it is notable that the US is now the only country which is explicitly planning for larger budget deficits, and higher public debt to-GDP, over the next half decade. Hot on the heels of the CBO analysis last week, this report again shows just how unprecedented current US policy action (deliberately expanding borrowing via the tax and omnibus spending bills) and inaction (on entitlement spending) is given the favorable economic conditions.


1 The IMF uses a different definition of debt here – gross government debt – whereas figures usually reported in the media, and by the Congressional Budget Office related to public debt held by the public.

Lots for Economists to Like in the House GOP Tax Plan

Debating the implications of the GOP tax plan, most analysts speak past each other. That’s because there are 3 prisms through which changes can be assessed: the implications for efficiency and growth, the impact on the public finances, and the distributional impact across income groups.

The media tends to focus on the latter, but this is the least interesting. Distributional analysis tends to put the status quo on a pedestal (see how “progressive” sources now defend the state and local income tax deduction), tends to be static in its thinking, and in the case of this tax reform, ignores the potential for significant corporate income tax rate cuts to raise wages. Added to that, a lot of the results are simply not surprising. Given a large proportion of people do not pay income taxes, it is hardly shocking that their after-tax income doesn’t increase following income tax rate cuts, though this can be influenced of course by credits.

As my colleague Chris Edwards has written before, the GOP open themselves up to these distributional critiques by talking about how their changes represent a “middle class tax cut” rather than focusing on the supply-side case for lowering marginal rates. As a result, this morning’s tax discussions on Twitter have been dominated by the sharing of blogs saying, in essence, that “the tax cut is actually a tax increase for much of the middle-class because the new credit is set to expire in 2022.” I am struggling to find blogs or comment pieces which used the same logic to explain why George W Bush’s temporary tax cuts weren’t really tax cuts at all, but hey, who expects consistency in politics!

On the efficiency and growth front, there is in fact lots to like in the House GOP plan. The changes to the income tax code stripped away a whole host of small deductions and made significant inroads into some big ones too (curtailing the mortgage interest deduction and eliminating the state and local income tax deduction), as well as abolishing the AMT. Of course, to make this politically palatable, the GOP near-doubled the standard deduction, expanded the child credit and added a new personal credit too. These will do little for growth, especially compared with purely lowering marginal rates, but they do help compensate losers from other changes.

The long-term consequence of the package of these reforms though (assuming they pass Congress without being further diluted) will be a combination of lower rates, fewer deductions and fewer people itemizing. This will significantly reduce deadweight costs associated with taxation. A key variable to watch out for to assess the broader economic impact of the income tax changes is the proportion of people who will face lower or higher marginal rates as a result of all the changes. One reason why this must be seen in the round is that linking tax thresholds to chained CPI rather than CPI will see slower threshold increases, meaning people being dragged into higher bands more quickly as nominal wages rise over time.

The most important policy goal was of course a large permanent cut in the corporate income tax rate, and this plan (if it passes) would achieve that. There is good reason to think this will raise the level of GDP and wages. Even though non-corporate businesses were already favored in the tax code once you include taxes on dividends, the GOP wanted to cut all business tax rates and broadly maintain differentials. They therefore introduced a new pass-through business tax rate at 25 percent. But this necessitates complex anti-avoidance rules to stop people restructuring their affairs to earn less wages and more business income.

The other, final change of note is the welcome planned repeal of the estate tax. This will not set be fully implemented until 2024, however, by which time the political landscape may have changed significantly.

Overall then, critics of the plan were wrong to say this was just about tax cuts without reform. In fact, the plan was a lot bolder on making changes to deductions and the structure of the code than many expected. Sure, other less growth-oriented measures were included to compensate some of the losers from broader reform, but overall the tax code is made more coherent.

The real debate for conservative economists should be weighing these efficiency gains against the consequences for the public finances. The plan is projected to add $1.5 trillion to the debt over 10 years, but even this is predicated on full expensing and the new income tax credits expiring after 5 years, which is debatable to say the least. The problem is that absent spending cuts, net tax cuts ultimately become tax shifting, leading to higher taxes in future.

A few weeks ago, I wrote that tax cuts which raised borrowing were worth it if they were used to grease the wheels of pro-growth tax reform or if they were a precursor to restraining spending. The latter looks unlikely. Whether the specific tax changes the GOP have planned got enough “bang for the buck” from the extra borrowing is an open question. Certainly, the priorities as this develops into legislation must be to keep the most economically beneficial measures: the corporate rate cut, the marginal income tax rate cuts, and the elimination and constriction of deductions.

The Current Budget Crisis Illustrates James Buchanan’s Concerns About Politics

Nobel laureate James Buchanan has been in the news lately, especially because of a book that seeks to link his 7000 pages of economic writing to both Dixiecrat segregationists and Charles Koch’s secret plan “to radically alter our government in ways that will be devastating to millions of people.” The thesis of Democracy in Chains by Nancy MacLean is that public choice economics is a radical plan to “shackle the people’s power,” “to put democracy in chains.” Oddly, she claims (without evidence), he set out on this project because he resented the Supreme Court’s decision in Brown v. Board of Education – which of course used “undemocratic” means to overturn the democratic decisions of legislatures in various states.

Buchanan certainly was concerned with how to achieve justice, efficiency, and “prevention of discrimination against minorities” in the context of majority rule. Throughout his work he explored how to design constitutional rules to bring about optimal outcomes, including a balanced budget requirement, supermajorities, and constitutional protection of individual rights. He worried that both majorities and legislatures would be short-sighted, economically ignorant or inefficient, and indifferent to the imposition of burdens on others.

And today a Washington Post column by Dana Milbank illustrates one of the big problems that Buchanan sought to solve: the temptation of legislatures to spend money with little regard for what two of his students called “deficits, debt, and debasement.” Looking outward from Hurricane Harvey to the upcoming congressional session, Milbank wrings his hands:

Harvey makes landfall in Washington as soon as next week, when President Trump is expected to ask for what could be tens of billions of dollars in storm relief. And paying for storm recovery — probably with few offsetting spending cuts — will be but the first blow to fiscal discipline in what looks to be a particularly active, and calamitous, spending season.

It’s not just disaster relief. The Pentagon is hoping for tens of billions of additional dollars. And Republicans may pivot from “tax reform” to mere tax cuts. It’s easier just to spend money and cut taxes than to reform the flood insurance program, make the tax system more efficient, and focus military spending on actual defense needs, much less to think about the national debt and the next generation.

Your Guide to the NAFTA Renegotiation

The North American Free Trade Agreement has been a source of controversy since well before its implementation in 1994.  It was the first trade agreement involving the United States and a “developing” country, so it raised concerns that a giant sucking sound from south of the border would hoover up U.S. investment and jobs.  Ross Perot, Pat Buchanan, and most Democratic presidential candidates beginning with John Kerry all lamented the imminent or unfolding devastation wrought by NAFTA.

Even though the U.S. manufacturing sector has continued to attract more investment than every other countries’ manufacturing sectors ever since NAFTA was implemented, and even though that implementation did not accelerate the trend of U.S. manufacturing job decline, which had been underway for 14 years since employment peaked at 19.4 million in 1979 (2.6 million decline between 1979 and 1993; 2.7 million decline between 1993 and 2007; 600,000 increase between 1993 and 1999), NAFTA became a symbol of corporate excess and a rallying cry for organized labor, environmental organizations, and other anti-business groups over the years.  It also made it nearly impossible for Democrats in Congress to support trade liberalization in the ensuing decades.

During the 2008 presidential election campaign, Democratic candidates John Edwards, Hillary Clinton, and Barack Obama all vowed to re-open NAFTA to make it less unfair for U.S. workers.  Within a few weeks of assuming office, President Obama let the president of Mexico and the prime minister of Canada know that he wasn’t about to follow through on his NAFTA pledges and risk disrupting North American production and supply chains that have enabled regional producers to compete more effectively against Asian and European rivals, while delivering better goods and services at more affordable prices to consumers.

Probably owing to the anti-trade agreement fervor that brewed during the debates over Trade Promotion Authority and the Trans-Pacific Partnership over the last few years, killing NAFTA (and the TPP) became a central plank in Donald Trump’s presidential campaign. Although, regrettably, he withdrew the United States from the TPP, Trump seems to have been talked off the ledge about jettisoning NAFTA , which (as of this morning) is being renegotiated.

As a guide to better understanding what’s on the table and what’s at stake, my colleagues Simon Lester, Inu Manak, and I produced this working paper: Negotiating NAFTA in the Era of Trump: Keeping the Trade Liberalization In and the Protectionism Out.

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In Just Six Minutes, Everything You Need to Know about Spending Caps

Back in April, I shared a new video from the Center for Freedom and Prosperity that explained how poor nations can become rich nations by following the recipe of small government and free markets.

Now CF&P has released another video. Narrated by Yamila Feccia from Argentina, it succinctly explains - using both theory and evidence - why spending caps are the most prudent and effective way of achieving good fiscal results.

Ms. Feccia covers all the important issues, but here are five points that are worth emphasizing.

  1. Demographics - Almost all developed nations have major long-run fiscal problems because welfare states will implode because of aging populations and falling birthrates (Ponzi schemes need an ever-growing number of new people to stay afloat).
  2. Golden Rule - If government spending grows slower than the private sector, that reduces the relative burden of government spending (the underlying disease) and also reduces red ink (the symptom of the underlying disease).
  3. Success Stories - Simply stated, spending caps work. She lists the nations that have achieved very good results with multi-year periods of spending restraint. She points out that the U.S. made a lot of fiscal progress when GOPers aggressively fought Obama. And she shares the details about the very successful constitutional spending caps in Hong Kong and Switzerland.
  4. Better than Balanced Budget Amendments or Anti-Deficit Rules - The video explains why policies that try to target red ink are not very effective, mostly because tax revenues are very volatile.
  5. Even International Bureaucracies Agree - Remarkably, the International Monetary Fund (twice!), the European Central Bank, and the Organization for Economic Cooperation and Development (twice!) have acknowledged that spending caps are the most, if not only, effective fiscal rule.

I touch on some of these issues in one of my chapters in the Cato Handbook for Policymakers. The entire chapter is worth reading, in my humble opinion, but I want to share an excerpt echoing Point #4 that I just shared from Ms. Feccia’s video.

There’s a very practical reason to focus on capping long-run spending rather than trying to balance the budget every year. Simply stated, the “business cycle” makes the latter very difficult. …when a recession occurs and revenues drop, a balanced-budget mandate requires politicians to make dramatic changes at a time when they are especially reluctant to either raise taxes or impose spending restraint. Then, when the economy is enjoying strong growth and producing lots of tax revenue, a balanced-budget requirement doesn’t impose much restraint on spending. All of which creates an unfortunate cycle. Politicians spend a lot of money during the good years, creating expectations of more and more money for various interest groups. When a recession occurs, the politicians suddenly have to slam on the brakes. But even if they actually cut spending, it is rarely reduced to the level it was when the economy began its upswing. Moreover, politicians often raise taxes as part of these efforts to comply with anti-deficit rules. When the recession ends and revenues begin to rise again, the process starts over—this time from a higher base of spending and with a bigger tax burden. Over the long run, these cycles create a ratchet effect, with the burden of government spending always reaching new plateaus.

It’s not that I want to belabor this point, but the bottom line is that it is very difficult to amend a country’s constitution (at least in the United States, but presumably in other nations as well).

So if there’s going to be a major campaign to put a fiscal rule in a constitution, then I think it should be one that actually achieves the goal. And whether people want to address the economically important goal of spending restraint or the symbolically important goal of fiscal balance, what should matter is that a spending cap is the effective way of getting there.

The Five Most Important Takeaways from Trump’s Budget

It’s both amusing and frustrating to observe the reaction to President Trump’s budget.

I’m amused that it is generating wild-eyed hysterics from interest groups who want us to believe the world is about to end.

But I’m frustrated because I’m reminded of the terribly dishonest way that budgets are debated and discussed in Washington. Simply stated, almost everyone starts with a “baseline” of big, pre-determined annual spending increases and they whine and wail about “cuts” if spending doesn’t climb as fast as previously assumed.

Here are the three most important things to understand about what the President has proposed.

First, the budget isn’t being cut. Indeed, Trump is proposing that federal spending increase from $4.06 trillion this year to $5.71 trillion in 2027.

 

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