Topic: Finance, Banking & Monetary Policy

Second Doubts about a Border-Adjustable Corporate Tax (BACT)

First Doubts” dealt with predictions that a 25% rise in the dollar could make a 20% tax on imports disappear with only temporary effects on trade but a $1.2 trillion increase in tax revenues (which would supposedly be paid by foreigners, and without complaint).  

Second Doubts will focus on a key claim that border adjustability is needed because “exports from the United States implicitly bear the cost of the U.S. income tax while imports into the United States do not bear any U.S. income tax cost.”   And we’ll question whether border adjustability is justified because corporate “cash flow” taxes under the House GOP plan are more like value-added taxes than corporate income taxes in other countries.

A Better Way” (a House Republican discussion document of June 24, 2016) says, “In the absence of border adjustments, exports from the United States implicitly bear the cost of the U.S. income tax while imports into the United States do not bear any U.S. income tax cost. This amounts to a self-imposed unilateral penalty on U.S. exports and a self-imposed unilateral subsidy for U.S. imports [emphasis added].”  

That statement makes the case for “border adjustment” – which means the costs of imports (unlike equivalent domestic costs) would cease to be tax-deductible for business and rewards from selling exports would cease to be taxable.  

Since all countries have corporate income taxes, what could it possibly mean to say only our own corporate income tax is an “implicit” tax on exports?  Who pays this “implicit” tax?

What could it mean to say that failure to impose U.S. income tax on foreign factories is a “subsidy to imports?”  

Baptists and Bootleggers in the Organized Effort to Restrict the Use of Cash

In a classic account of why prohibitions and other economic restrictions harmful to consumers arise and persist, economist Bruce Yandle noted that such restrictions are often promoted by a coalition between two groups. The first group are morally motivated do-gooders (“Baptists”) who think that the restrictions will promote the public interest. The second group are profit-motivated business people (“bootleggers”) who may adopt the language of the first group but whose aim is to profit by legally quashing potential competition. In Yandle’s example, the prohibition of liquor in the United States during the 1920s was loudly promoted by Baptists and others who considered liquor consumption sinful, and quietly backed by bootleggers whose profits from rum-running depended on the absence of legal liquor.

In today’s organized effort to restrict or prohibit the use of cash we can see the same kind of coalition. The metaphorical Baptists include leading economic advisors like Kenneth Rogoff (recently labeled by one Indian writer “the high priest of demonetisation”) and Larry Summers. They argue that banning cash would fight crime and helpfully give additional power to monetary policy-makers (by enabling negative nominal interest rates). I have criticized these arguments for currency prohibitionism before. Other presumably disinterested advocates advance the implausible claim that reducing the payment options of the world’s poor by banning cash will benefit the poor by promoting “financial inclusion.” I scrutinize this claim below.

First Doubts about Border Adjustability

President Trump created a stir by dismissing as “too complicated” the border adjustability feature in the House Republican corporate tax reform. Yet a few days later his press secretary Sean Spicer suggested the seemingly rejected border tax could pay for a Mexican border wall.   

Meanwhile, the President suggested the dollar is “too strong” even though (1) Commerce Secretary Wilbur Ross boasted about Trump having talking the Mexico peso down 35% and (2) Martin Feldstein and other economists pushing border adjustability predict that the plan would push the dollar 25% higher. 

To call border adjustability too complicated is starting to look like a huge understatement. 

In the House Republicans’ tentative “Better Way” plan, border adjustment means corporations could no longer treat expenses of imported materials, parts, or equipment as a cost doing business. Manufacturers of electrical machinery or plumbing parts could not deduct the cost of copper (36% of which is imported).  Retailers could not deduct the cost of imported goods. Refiners would pay a 20% tax on crude oil from Canada.

Exports, by contrast, would not count as income for U.S. tax purposes. Big exporters might even qualify for a federal check. “Any border adjustment should include cash refunds for exporters,” writes economist Alan Viard.   

This “border adjustability” is said to be comparable to the way we exempt foreigners from our sales and excise taxes and other countries likewise exempt us from their equivalent value added taxes (VAT). But that analogy depends on treating a tax on corporate cash flow (essentially income minus expensed investments) as equivalent to a tax on sales. I plan to discuss the VAT analogy in a separate blog.

Tax Policy Center economist Bill Gale notes, “Many economists—but very few non-economists—believe that the international trade effects of border adjustments will be small.” Indeed, the architects of the House GOP plan, as well as potential winners and losers among business leaders, depict the House GOP tax proposal as an export incentive and import penalty. So does economist Diana Furchtgott-Roth who writes, “Border adjustability taxes are essentially tariffs under another name.” Carolyn Freund of the Peterson Institute likewise shows how a “Maryland-produced sweatshirt will face a lower tax rate than the Chinese-produced sweatshirt, exactly as if a tariff were applied.” Foreign trading partners will surely see it the same way.  

How can economists disagree? “In a simple textbook model,” explains Alan Viard, “a border adjustment would trigger a real increase in the value of the dollar that would raise the cost of U.S. exports and reduce the cost of U.S. imports by an amount that would exactly offset the direct effects of the border adjustment.”

This textbook model claims the so-called “destination-based cash-flow tax (DBCFT)” will not affect the U.S. trade deficit because, as Paul Krugman explains,  “wages and/or the exchange rate would change.” Rather than dealing with changing wages, border adjustment enthusiasts claim the real exchange rate of the dollar would supposedly rise “exactly” enough to make U.S. exports sufficiently expensive to foreigners to “exactly” offset the export subsidy. And the dollar prices of foreign imports would likewise fall by “exactly” the right amount to compensate for the importers’ extra 20% tax, neither more nor less.  

“If the dollar doesn’t rise quickly enough or high enough,” notes The Wall Street Journal, “a border-adjusted tax is expected to penalize big retailers and other large corporations reliant on lower-cost foreign production.” Even if we could be certain of the real exchange rate rising by 25%, past experience does not suggest that is likely to happen in fewer than four years, or that import prices would fall proportionately or uniformly.

The Curse of Motivated Reasoning against Econ 101

Earlier this month, James Kwak penned an extensive critique for The Atlantic of the Econ 101 view that government-imposed minimum wage rates lead to job losses. There is a lot of muddled thinking in the article, not least that it constantly conflates poverty and inequality. But for the sake of brevity, here are 9 observations:

  1. The theoretical and empirical literature does suggest the minimum wage question is more complex than first imagined, and it should not surprise us that reality lies somewhere between the perfectly competitive model of the labor market and the monopsonistic one, depending on the time and sector analyzed.
  2. However, the bulk of the detailed empirical literature still supports Econ 101’s prediction that raising wages by government dictat reduces labor demand, particularly for certain groups (the young and lowest skilled). Of course, the “bite” of the minimum wage is significant. That an increase from $7.25 to $8 may not have a large effect on the labor market does not mean that a rise to $15 wouldn’t have a much bigger effect.
  3. Reductions in labor demand need not mean higher unemployment per se (and so tracking time series of unemployment against minimum wage rates is unhelpful.) It may affect hours offered, lower the quality of jobs as firms cut back on financing training, or lead to cuts to other employee benefits. More recent evidence also stresses the dynamism of the labor market – minimum wage hikes may not manifest themselves through immediate job cuts (not least because of redundancy costs and stickiness of contracts/orders), but can lower the propensity to hire in future and hence slow job growth.

Interest On Reserves: A Secret Fiscal Weapon We’re Better Off Without

Whenever a government agency gains a new power, there’s a risk that, whatever the power’s original intent, it will end up being put to other uses, perhaps good, but often bad.

Such is the case for the Fed’s power to pay banks interest on their Federal Reserve deposits. That power was originally awarded to the Fed in 2006 to allow it, starting in October 2011, to reduce banks’ cost of meeting statutory reserve requirements. During the financial crisis the implementation date was moved forward to October 2008, the Fed’s hope at the time having been that a positive interest rate on excess reserves (IOER) would establish a new, above zero “floor” for the effective federal funds rate. However, as I explained in a recent post, because subsequent Fed reserve creation left the banking system flush with reserves, banks had no need to borrow federal funds unless they could profit from the difference between the borrowing rate and the IOER. Consequently, the interest rate on reserves, instead of serving as an effective funds rate floor, ended up becoming a ceiling.

Fed Ed Failure File Just Got Fatter

In the aftermath of Betsy DeVos’s confirmation hearing—but really, anytime someone’s talking about federal education policy—it is important to look at evidence. Today we’ve got several items to add to the evidence pile, none of them good for fed ed.

The first is a new report on the School Improvement Grants program, an initiative aimed at turning around troubled schools with various possible interventions ranging from replacing principals to closing schools. What did the report find? The multi-billion dollar undertaking “had no impact on math or reading test scores, high school graduation, or college enrollment.”

Next, to higher education. A Wall Street Journal article today reports that the U.S. Department of Education widely overstated the repayment rate of student loans. Indeed, when the Journal recalculated the numbers, “the data revealed that the Department previously had inflated the repayment rates for 99.8% of all colleges and trade schools in the country.” The problem, according to an education department spokesperson cited in the article: a programming error.

Finally, we come to Navient, a company that exists largely on a contract to service student loans for the U.S. Department of Education. Yesterday the Consumer Financial Protection Bureau (CFPB)—itself a big federal fiasco—announced that it was suing Navient for deceptive and exploitative practices it allegedly undertook to cut costs and maximize revenues.

The CFPB isn’t entirely known for its own straight shooting, so Navient should get the benefit of the doubt. But it is certainly plausible that this government-privileged company takes advantage of its largely captive clientele. And who is Navient’s mother, by the way? Why none other than Sallie Mae—the company was spun off from Sallie in 2014—which was originally a government-sponsored enterprise like Fannie and Freddie, created by Washington to buy and service student loans in 1972.

In her confirmation hearing, Betsy DeVos pretty consistently indicated an aversion to federal power. The evidence is on her side, and growing every day.

The World’s Most – And Least – Miserable Countries in 2016

In what follows, I update my annual Misery Index calculations. A Misery Index was first constructed by economist Art Okun as a way to provide President Lyndon Johnson with a snapshot of the economy. 

The original Misery Index was just a simple sum of a nation’s annual inflation rate and its unemployment rate. The Misery Index has been modified several times, first by Robert Barro of Harvard and then by myself. My modified Misery Index is the sum of the unemployment, inflation, and bank lending rates, minus the percentage change in real GDP per capita. A higher Misery Index score reflects higher levels of “misery,” and it’s a simple enough metric that a busy president without time for extensive economic briefings can understand at a glance.

Below is the 2016 Misery Index table. For consistency and comparability, all data come from the Economist Intelligence Unit (EIU).