Tag: gross domestic product

Corporate Tax Cuts: Canada’s Experience

President Donald Trump and congressional Republicans are proposing to cut the corporate tax rate. With any tax cut, members of Congress want to know how much revenue the government may lose from the reform. I do not think that cutting our 35 percent federal corporate tax rate to 20 percent or so would lose the government any money over the long term. U.S. and foreign corporations would invest more in the United States, which would boost our economy, and corporations would avoid and evade taxes less.

Canada provides us with a real-world trial run of corporate tax cuts, and new budget data includes the latest revenue estimates. The nation slashed its federal corporate tax rate from 38 percent in the mid-1980s, to 29 percent by 2000, to 15 percent by 2012, as shown in Chart 1 below. Has the government lost revenue?

You be the judge. Chart 2 shows that corporate tax revenues in Canada have fluctuated with the ups and downs in the economy—revenues fell, for example, during recessions in the early 1990s and 2009. But even with the modest Canadian economic growth of recent years, revenues have held up under a much lower rate. Corporate tax revenues are 2.1 percent of gross domestic product (GDP) today, which is a bit higher than in the mid-1980s when the rate was more than twice as high.

Let’s compare to the United States. While Canada’s 15 percent federal corporate tax will raise 2.1 percent of GDP this year, the 35 percent U.S. federal corporate tax will raise just 1.7 percent. Thus, the Canadian corporate tax raises relatively more than the U.S. tax—even though the rate is less than half the U.S rate.

 

 

Canada historic tax revenues here. New Canadian budget data here.

 

The Consumer Spending Fallacy behind Keynesian Economics

I’m understandably fond of my video exposing the flaws of Keynesian stimulus theory, but I think my former intern has an excellent contribution to the debate with this new 5-minute mini-documentary.

The main insight of the mini-documentary is that Gross Domestic Product (GDP) only measures how national output is allocated between consumption, investment, and government. That’s useful information in many ways, but if we want more output, we should focus on Gross Domestic Income (GDI), which measures how national income is earned.

Focusing on GDI hopefully would lead lawmakers to consider ways of boosting employee compensation, corporate profits, small business income, and other components of national income. Focusing on GDP, by contrast, is misguided since any effort to boost consumption generally leads to less investment. This is why Keynesian policies only redistribute national income, but don’t boost overall output.

You may recognize Hiwa. She narrated a very popular video earlier this year on the nightmare of income-tax complexity.

China Now World’s 2nd Largest Economy: Ho Hum

China is now officially the world’s second largest economy, overtaking Japan in the quarter that ended in June and likely for all of 2010. While the story has been widely reported (more than 1,500 articles on Google News this morning), it is less significant than it first appears.

The news will probably ruffle the feathers of the China hawks, who will see in it a threat to America’s influence in the world, but China’s rise to no. 2 is really another sign of the world returning to normal.

China is home, after all, to one-fifth of mankind. Its population of 1,330 million is more than 10 times that of Japan (127 million) and more than four times that of the United States (310 million), according to the CIA Factbook. So even though China’s gross domestic product is now larger than Japan’s, its GDP per capita is still only one tenth that of its east Asian neighbor.

If China sticks to its path of market liberalization, it’s close to inevitable that its GDP economy will eventually surpass that of the United States in overall size. That news event is likely to grab headlines in 15 to 20 years based on current rates of growth. Even then, China’s per capita GDP will only be a quarter of what we enjoy in the United States.

China’s rank as no. 1 will be nothing new in history. According to the late British economic historian Angus Maddison, China’s economy had been the largest in the world for most of the past two millennia. In his magisterial 2001 book The World Economy: A Millennial Perspective, Maddison estimated that as recently as 1820 China’s GDP was 30 percent larger than the economies of Western Europe and the United States combined (p. 117).

After centuries of war, civil strife, and self-imposed isolation, China is only now rightfully reclaiming its rank as one of the world’s largest economies. That development is nothing to be feared.

Unions and Government Debt

In a recent bulletin, I argued that public-sector unions impose various costs and burdens on state and local governments. Here is some more evidence.

The chart below shows a scatter plot of the union shares in state/local government workforces and state/local government debt levels as a share of state gross domestic product. Each blue dot is a U.S. state.

The variables are correlated – as the union share increases, a state tends to have a higher government debt load. The chart shows the fitted regression line in pink dots (R-square=0.27; F-stat=18; t-stat on the union share variable=4.2).

The correlation is likely caused by the fact that unionized government workers are powerful lobby groups that push for higher government-worker compensation and higher government spending in general.

(Thanks to Amy Mandler for data help and Andrew Biggs for suggestions. Andrew’s work on state debt is here).

Another Reason Imports Get a Bad Rap

Why blame only media and politicians for the public’s confusion about imports and trade deficits? Surely economists deserve some scorn. Some of the misunderstanding can be traced to the famous National Income Identity, which expresses gross domestic product, as: Y = C + G + I + (X-M). That is, national output (Y) equals personal consumption (C) plus government spending (G) plus investment (I) plus exports (X) minus imports (M).

The expression clearly lends itself to the wrong interpretation. The minus sign preceding imports suggests a negative relationship with output. It is the reason for the oft-repeated fallacy that imports are a drag on growth. Here’s why that conclusion is wrong.

The expression is an accounting identity, which “accounts” for all of the possible channels for disposing of our national output. That output is either consumed in the private sector, consumed by government, invested by business, or exported. The identity requires subtraction of aggregate imports because consumption, government spending, business investment, and exports all contain, in various amounts, import value. Americans consume domestic and imported products and services, the aggregate of which shows up in Consumption. Likewise, Government purchases include domestic and imported products and services; businesses Invest in domestic and imported machines and inventory; and, eXports often contain some imported intermediate components. Thus, the identity would overstate national output if it didn’t make that adjustment for iMports. After all, imports are not made on U.S. soil with U.S. factors of production, so they shouldn’t be included in an expression of our national output.

To reiterate, it is a simple matter of accounting: as an expression of national output, the National Income Identity subtracts imports only because imports are that portion of consumption, government spending, investment, and exports that are not produced on U.S. soil with U.S. factors of production. If we did not subtract an aggregate import value, then national output would be overstated.

But what unnecessary confusion that identity has created. Economists are often indecipherable, but here was an opportunity to actually connect with the public and describe a relatively easy concept in relatively easy terms. Why has it not been commonplace to use notation that conveys in no uncertain terms that C and G and I and X include some amount of imports? Maybe something like this:

Y=C(d)+C(m)+G(d)+G(m)+I(d)+I(m)+X(d)+X(m)-M,

where (d) connotes domestic; (m) connotes imported; and M=C(m)+G(m)+I(m)+X(m).

Again, imports are subtracted, not because they are a drag on output, but because imports are included in the other constituent elements of the identity. I’ve always found it misleading that the parentheses go around X-M – which isolates the expression “net exports,” but in the process can obscure the fact that imports are subtracted from the whole expression.

Finally, if the description above makes sense, then you’ll agree that imports have NO impact on national output. Regardless of how large or small, the import value embedded in the four constituent elements of national output is fully deducted by subtracting M. Thus, imports are neither a drag on GDP, nor can they cause GDP to rise. That conclusion may sound like it contradicts one of my assertions in yesterday’s post—that imports are pro-cyclical—(at least that was the claim of a NBER economist responding my post yesterday), but I think the conclusions are harmonious. To say imports are pro-cyclical means that they rise when the economy is growing and fall when the economy is contracting. It says nothing about causation.  That pattern has been amply and consistently demonstrated through expansion, recession, and recovery.

Topics:

Government and GDP

The expansion in government and poor state of the economy got me thinking about how government growth is reflected in measured gross domestic product. So here is a wonky look at the treatment of government in the Bureau of Economic Analysis GDP data.

Data notes: By “government,” I mean total federal, state, and local. For 2009, I’m using the average of second and third quarter data. All data from BEA Tables here.

GDP measures total production. In 2009, government production was 20.7 percent of U.S. GDP.  Government production is roughly the sum of government value-added (the stuff it produces itself) and government purchases. The first item, government value-added, was 12.4 percent of GDP and mainly consists of employee compensation. For example, the Pentagon produces output by adding together fighter pilots, which it hires, and fighter jets, which it buys.

A more commonly cited measure of government is total government spending. In 2009, that was 38 percent of GDP. The difference between this number (38 percent) and the production number (20.7 percent) is 17.3 percent, and represents the sum of government interest payments and transfer payments to individuals and businesses.

Figure 1 shows how the three measurements of government size have changed over time. Government production has remained fairly stable as a share of the economy, but total government spending has soared. The growing gap between these two lines mainly represents the massive growth in transfer (or subsidy) programs, such as Social Security.

12-10-09 edwardschart

How Does Government Growth Affect Measured GDP?

Consider how the recent rise in government spending might have affected measured GDP. First, let’s look first at the production part of government spending. The important thing here is that we don’t know how much government workers actually produce because their output is generally not sold on the market. As a consequence, the BEA measures their output as the sum of their compensation amounts. Also, we know the dollar value of the things the government buys, but we don’t know how much those intermediate goods actually produce when in the hands of the government. So the government production portion of GDP seems kind of shaky, despite the superb efforts of the BEA to assemble all the data.

Anyway, let’s say the government adds a new worker with pay of $100,000, the BEA measures GDP being boosted by $100,000. But it might be that the worker doesn’t actually produce anything useful, and he adds zero to the economy’s actual output.

If the government hires that worker away from the private sector, private GDP would go down by about $100,000. As a result, overall measured GDP would be unchanged. But that would be incorrect because the economy’s actual output fell by $100,000.

So let’s say the government spent $100 billion to hire a million new government workers. Let’s say half of those workers produced as much value as their salaries, but the other half produced nothing of value. The result of this government expansion would be that the BEA would overestimate U.S. GDP by $50 billion. (I am assuming that the government’s hiring doesn’t change the unemployment rate. I’m also ignoring the distortionary effects of higher taxes).  

Now let’s look at the transfer or subsidy portion of government, which equals 17.3 percent of GDP.

Let’s say the government increases transfers by $100 billion, perhaps by increasing Social Security benefits, and funding it by higher taxes on wages.

If there are no behavioral responses among taxpayers and benefit recipients, measured GDP would be unchanged, which would be the correct answer.

But of course there would be behavioral responses. The higher taxes would induce people to work less and the higher Social Security benefits would induce people to save less and retire earlier. The results would be that output would fall, and that would be accurately reflected in measured GDP.

In sum, my purpose here was not to explore how a growing government affects the economy, which is a huge subject. Instead, it was to explore whether measured GDP accurately reflects changes in the size of government. The answer appears to be that the transfer part of government spending (17.3 percent of GDP) would be accurately reflected in a shrinking GDP, but that the production portion of government spending (20.7 percent of GDP) may not be. If workers produce less output when they work for government than when they work in the private economy, the latter portion of measured GDP will be overstated.

Deficits, Spending, and Taxes

The White House and the CBO announced this week that:

The nation’s fiscal outlook is even bleaker than the government forecast earlier this year because the recession turned out to be deeper than widely expected, the budget offices of the White House and Congress agreed in separate updates on Tuesday.

The Obama administration’s Office of Management and Budget raised its 10-year tally of deficits expected through 2019 to $9.05 trillion, nearly $2 trillion more than it projected in February. That would represent 5.1 percent of the economy’s estimated gross domestic product for the decade, a higher level than is generally considered healthy.

What is the right response to these deficits?

One view holds that most current expenditure is desirable — indeed, that expenditure should ideally be much higher — so the United States should raise taxes to balance the budget. Taxes are a drag on economic growth, however, and unpopular with many voters, so this view presents politicians with an unhappy tradeoff.

The alternative view holds that a substantial fraction of current expenditure is undesirable and should be eliminated, even if the revenue to pay for it could be manufactured out of thin air. To be concrete:

  • Medicare and Medicaid encourage excessive spending on health care.
  • The invasions of Iraq and Afghanistan encourage hostility to the U.S. and thereby increase the risk of terrorism.
  • Drug prohibition generates crime and corruption.
  • Agricultural subsidies distort decisions about which crops to grow, and where.
  • And much, much more.

So, under this view, the United States can have its cake and eat it too: improve the economy and reduce the deficit without the need to raise taxes.

This approach is not, of course, politically trivial, since existing expenditure programs have constituencies that will fight their elimination.

But thinking about these two views of the deficits is nevertheless useful: it shows that discussion should really be about which aspects of government are truly beneficial, not just about the deficits per se.

C/P Libertarianism, A to Z