Tag: tax

Will Tariffs Consume the Tax Reform Benefits U.S. Manufacturers Were Expecting?

Former White House economist Gary Cohn expressed concerns yesterday that Trump’s tariffs would erode the benefits from tax reform. Since the on-again-off-again 25 percent tariffs on imports from China are—as of 3:23pm, Friday, June 15, 2018—“on again,” let me share this back-of-the-envelope analysis that shows why Cohn’s concerns are justified.

Certainly, the additional profits expected from the reduction in corporate rates from 35 to 21 percent could be entirely wiped out for the manufacturing sector. In 2017, according to Census Bureau data, the pre-tax profits of the U.S. manufacturing sector were $691 billion.  At 35 percent, the taxes on paper would be $242 billion.  At 21 percent, the average tax bill is $145 billion.  So, roughly speaking, the reduction in rates is estimated to be worth about $97 billion in terms of 2017 profits.

Well, in 2017, the value of U.S. goods imports was $2.33 trillion. Commerce Department data show that half of that value was comprised of intermediate goods (raw materials, production inputs, capital equipment)—the purchases of producers, not households. In other words, approximately $1.17 trillion of imports are U.S. costs of production.

If a tariff of, say, 10 percent were imposed on these imports, the cost of production for manufacturers would rise, roughly speaking, by $117 billion. That’s a $117 billion reduction in profits. Meanwhile, assuming foreign governments responded in kind and hit U.S. exports with 10 percent tariffs, manufacturing revenues also would take a hit.  U.S. exports of manufactured goods in 2017 amounted to $1.24 trillion.  Again, roughly speaking, that 10 percent tariff would reduce U.S. manufacturing revenues by $124 billion.  That, too, reduces profits.

The combined effect of the increased costs and reduced revenues comes to a $241 billion reduction in profits (a 35 percent reduction in manufacturing’s 2017 pre-tax profits). So, ceteris paribus, a 10 percent across-the-board tariff would reduce the U.S. manufacturing sector’s profits by about 35 percent.  With that kind of “downturn” in profitability, from where would the resources come to make capital investments, build new production facilities and R&D centers, and to offer new employment opportunities?

Let’s apply this ball park estimate to the actual situation on the ground. The tariffs Trump has already imposed or announced (steel and China tech products—leaving out aluminum, washers, and solar panels) subject $100 billion of imports to tariffs of 25 percent. The retaliation so far announced (by China, Canada, Mexico, and the EU) is commensurate—it will be approximately 25 percent on $100 billion of U.S. exports.  So, at the moment, $200 billion of U.S. trade is in the crosshairs.

But a new Trump investigation into the national security implications of auto and auto parts imports could add another $600 billion of trade to the mix—$300 billion of imports hit with 25 percent duties and $300 billion of retaliation. The president wants to get the investigation completed before the election in November, so we could be up to $800 billion of U.S. trade by year’s end.  (That’s 20 percent of all U.S. goods trade, by the way.)  

So, 25 percent duties assessed on $800 billion of trade, approximately half of which would be U.S. manufacturing inputs and U.S. manufactured exports comes out to a combined $100 billion hit on the sector’s profits (25 percent of $400 billion).  That eclipses the $97 billion gain from the corporate rate reduction.

While this is all bad news for the economy, I wonder whether the tax-reform advocates who held their noses and excused Trump’s trade transgressions because tax reform would make everything right will start to speak out. Paging Larry Kudlow, Steve Moore, and Art Laffer.

 

 

 

 

 

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Partisans”R”Us

The success of the corporate tax cut should ultimately be judged by corporate investment levels and wage growth, not share buybacks or one-off bonuses.

Investment is the mechanism through which corporate rate cuts lead to higher productivity and higher compensation, and the Republican plan was explicitly designed to improve the marginal incentive to invest.

Yet announcements made by hundreds of businesses for one-off bonuses for workers and even share buybacks can still be a direct consequence of the tax cut.

There are two economic mechanisms at work here, which John Cochrane has outlined: “incentives” and “cashflow”. The former is the more important, but the latter is what we are seeing so far.

Ryan Bourne: Corporate Tax Cut will Help Workers and Shareholders

In case you missed it over the weekend, Cato scholar Ryan Bourne wrote about the Republican tax reform plan in an op-ed featured in The Hill. He responds to the argument that corporations will use money saved from the reduction in the federal corporate tax rate to increase dividends, buy back shares, or other strategies that benefit their shareholders. 

Major companies, including Cisco Systems, Pfizer and Coca-Cola, have said they will use most of the gains from proposed corporate rate cuts to increase dividends to shareholders or buy back their own shares. This has been reported and shared on Twitter as a slam dunk against the Republican tax plan.

After all, a major claim of the administration has been that corporate rate cuts would benefit workers through wage rises, rather than flowing exclusively to capital owners.

Yet, the reaction of these companies is nothing unexpected, at least in the short term. Any substantial cut to the corporate rate provides an immediate windfall to so-called “old capital.”

But even though the initial beneficiaries of changes in the corporate tax rate will indeed be corporate shareholders, Bourne points out that those savings have to go somewhere. 

If existing firms have excess capital in the short-term, distributing it to shareholders in some way makes sense. This money is unlikely to sit dormant afterwards. In all likelihood, that money will be deployed elsewhere to find new value.

The market for growth industries through venture capital and angel investment is huge, and these windfalls can be invested in the start-ups and industries of the future.

The key point though is that the lower corporate rate improves the after-tax profitability of investment across the economy, and as such generates new activity. Other things given, domestic companies will have greater incentive to invest.

Foreign companies will be more likely to expand their investments in the U.S. — or even shift their operations here. U.S. companies will repatriate profits earned by their foreign subsidiaries rather than leaving them abroad, and more capital will flow from other less productive U.S. sectors into the U.S. corporate world. 

Read the op-ed here

Trump’s Wall Plan Is Disgraceful, Belligerent, and Disastrous

Regardless of whether wall construction is funded through a discriminatory tariff on imports from Mexico or the border adjustment taxes envisaged in the GOP tax proposal, U.S. consumers and taxpayers will be flipping the bill.  The very idea of building the wall in the first place is a disgrace, but demonizing our neighbors and hatching plans that could subvert the Mexican economy and put another Venezuela on our southern border, is belligerent and potentially disastrous.

Hitting all Mexican imports with a 20% tariff is, unfortunately, something the president could do.  Under the Constitution, Congress is authorized to regulate foreign commerce, which includes imposing tariffs.  But over the years, Congress has delegated some of that authority to the president through various statutes. All of those statutes require that some condition be met (findings of a surge in imports; subsidized imports; unfair foreign practices that hurt U.S. companies; national security crises; public health or safety threats, etc.) before restrictions can be imposed. Sometimes the restrictions are limited in magnitude and duration, sometimes not.  Sometimes the actions are subject to judicial review, sometimes not.

By and large, these statutes were passed in conjunction with legislation to implement trade agreements, lower tariffs, or otherwise liberalize trade.  They were crafted as safeguards to assuage those concerned that the country’s seemingly inexorable march toward free trade would bring rapid change, which would carry massive adjustment costs and other maladies and threats that the government would be incapable of addressing. The expectation was that the president would use this conditional power sparingly and in the service of greater openness and liberalization. In other words, unlike the Founding Fathers, U.S. Congresses during the 20th century failed to imagine adequately the likes of a Donald Trump as president.

How Growth Can Impact Spending and Why Spending Doesn’t Necessarily Drive Growth

The New York Times, in its infinite wisdom, has figured out how poor states can become rich states: simply put, they need only to increase taxes and spending. It recently publish a piece entitled “the Path to Prosperity is Blue” which suggested that the states that have maintained solid growth the last three decades largely owe that growth to high state government spending, and it suggested that the poor states follow that formula as well. 

The statistical derivation of this conclusion comes from the fact that the wealthiest states of the U.S. tend to be blue states, which have higher taxes and spending. By this logic, spending drives growth. 

While there is indeed a relationship between a state’s spending and its GDP, the causality is completely contrary to what the Times portrays. The reality is that states that become prosperous invariably spend more money. Some of that can represent more spending on public goods–Connecticut does seem to have better schools than Mississippi–but far more of it is simply captured by government interests. While California may have made have created a quality public university system in the 1950s and 1960s with its newfound wealth, the reason its taxes are so high today is because it has a ruinous public pension system it needs to finance. Their high spending isn’t doing its citizenry any good at all. 

New York City and California. two high tax regions, became prosperous in large part because they were (and remain) a hub for immigrants and ambitious, entrepreneurial Americans who helped create the industries that to this day drive the economies of each state. California’s defense and IT industry did benefit from public investment as well, of course, but it was investment from the federal government, and in each case it merely served as a catalyst for the development of industries that went far beyond the government’s initial investment. 

To tell Mississippi that it could become prosperous and pull its citizenry out of poverty if it only doubled taxes is an absurd notion that amounts to economic malpractice. What Mississippi has to do is figure out how to attract and retain talented individuals, which is easier said than done. Unfortunately, the Jacksons and Peorias of the world are not lures to the ambitious Indian engineer or Chinese IT professional, who’d rather take their chances in Silicon Valley, Los Angeles, or anywhere else where the quality of life is good and jobs are plenty.

The lesson to take away from a comparison of the economic status of the fifty states is that economies of agglomeration is a vaguely-understood but critically important phenomenon, location matters, and that it is enormously difficult for states to pivot when their main industries falter. None of these can be said to be driven by government spending.

Oldsters vs. Youngsters

Ten years ago, if you walked down the street looking at faces passing by, you could have counted off “young, young, young, young, young, old …”. Fifteen years from now, if you do the same, it’s going to be “young, young, young, old …”.

That’s a striking bit of data included in new CBO budget projections. America has already grayed, but it’s nothing like what’s ahead. The number of old folks is going to soar over the next 20 years. The chart below shows that the ratio of oldsters (age 65+) to youngsters (age 20 to 64) is rising from 1-to-5 to more than 1-to-3. Is America ready for that radical shift?

The federal budget isn’t ready. Politicians have failed to reform oldster subsidy programs, with the sad result that the livelihoods of youngsters will be dragged down by an anchor of debt and taxes. The first, third, and fourth largest federal programs (Social Security, Medicare, Medicaid) transfer vast and increasing resources from young taxpayers to old retirees. There’s no justice in that, and social tensions will rise as the unfairness becomes ever more obvious in coming years.  

There is good news, however. When I’m flipping around radio stations in my car today, it’s teen pop, teen pop, teen pop, classic rock. But when I’m an oldster in the 2030s, it’s going to be classic rock, classic rock, classic rock. To me at least, that will be fair and just.

Philadelphia’s Soda Tax

The Philadelphia City Council has voted to become the second city in the United States to impose a tax on the sale of particular types of sweetened beverages. The tax applies to sugared soda, diet soda, sports drinks and more, while excluding drinks that are more than half milk or fruit, as well as drinks to which sugar is added such as coffee. The tax will be 1.5 cents per ounce, amounting to 18 cents per standard size can of soda or $1 per two-liter bottle.

Public health advocates often propose taxes on sugary drinks, colloquially known as “soda taxes,” as a means of improving public health outcomes. They argue that such beverages disproportionately cause obesity and that consumers of sugary beverages impose external costs on others through higher medical costs associated with obesity.

The evidence supporting the disproportionate effect of sugar beverages on obesity is not powerful.  An article in Obesity Review concluded, “The current evidence does not demonstrate conclusively that nutritively sweetened beverage consumption has uniquely contributed to obesity or that reducing NSB consumption will reduce BMI levels in general.” 

And the externalities of the obese also appear to be minimal.  “The existing literature … suggests that obese people on average do bear the costs and benefits of their eating and exercise habits.”

But for purposes of discussion assume that consumption of such beverages does result in obesity and its health effects, which, in turn, create costs for others.  Are the taxes a good corrective?

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