How Much Defense is Enough? The Outlier’s Take

A new study from the Center for Strategic and Budgetary Assessments, “How Much is Enough? Alternative Defense Strategies,” reports on military spending plans produced by teams from five think tanks, including Cato. CSBA asked each team to use its “Strategic Choices” software to make hundreds of choices amounting to a ten-year budget plan for the Pentagon and to provide a brief statement of their strategic rationale. The report includes those rationales, summaries of each budget, and comparative analysis of them.

As you can tell from the chart below, the Cato team’s answer was that way less is enough. We cut $1.1 trillion over the period. We’d have cut even more had the software allowed us to target all the spending going to “Overseas Contingency Operations,” intelligence programs and nuclear weapons. You can also see that our plan was the outlier. The others all raised spending—in AEI’s case, massively, by $1.3 trillion.

Tax Policy Center’s Flawed $6.2 Trillion Revenue Loss from Trump Tax Plan

A crucial graph in the Wall Street Journal article, “Trump Fiscal Plain Roils the GOP,” relies on estimates from the Tax Policy Center. Unfortunately, the TPC provides only static estimates of revenue effects of House Republican or Trump tax plans.  That is, they assume lower marginal tax rates on families and firms have literally no effect at all on tax avoidance or long-term economic growth. 

The Wall Street Journal graph purports to project budget deficits over the next 10 years under Congressional Budget Office (CBO) baseline, the House Republican tax plan and the Trump tax plan.  This is quite misleading, because all three scenarios treat future federal spending as given, unchangeable.  Federal spending rose from 17.6% of GDP in 2001 to 19.1% by 2007, and is now 20.7% in 2015. The 2017 Budget projects spending to reach to 22.4% by 2021 and keep rising. 

The CBO August baseline projects federal spending to total $50.2 trillion from 2017 to 2026, so a mere 5% reduction in that growth would exceed $2.5 trillion.

Under President-elect Trump’s revised tax proposal, claims the Tax Policy Center, “revenues would fall by $6.2 billion over the first decade before accounting for interest costs and macroeconomic effects. Including those factors, the federal debt would rise by at least $7 trillion over the first decade.” 

Do not confuse these alleged “macroeconomic effects” with dynamic analysis used in Tax Foundation models and academic studies. The Tax Foundation estimates, for example, that the House Republican tax plan “would reduce federal revenue by $2.4 trillion over the first decades on a static basis,” but that figure shrinks to $191 billion once they properly account for improved investment incentives,  greater labor and entrepreneurial effort and therefore faster economic growth. 

By contrast, the Tax Policy Center presents only “macro feedback” estimates for the Trump plan. The TPC Keynesian model and Penn-Wharton models assume that revenue losses are 2.6% of GDP, the same as static estimates.  But interest rates are higher, adding to deficits and debt.

Revenues from Trump Plan Unfairly Compared to Fanciful CBO Projections

Tax Policy Center estimate of a 10-year $6.2 trillion revenue loss is used to predict higher interest rates, and those higher interest rates prevent the economy from growing faster, which in turn vindicates the static assumption of a $6.2 trillion revenue loss.  

The circularity of this tangled fable is remarkably illogical.  How could interest rates remain higher if private investment is crowded out leaving GDP growth unchanged?

The TPC tells a similar story about the House Republican tax plan.  “Although the House GOP tax plan would improve incentives to save and invest, it would also substantially increase budget deficits unless offset by spending cuts, resulting in higher interest rates that would crowd out investment [emphasis added].”  This too is an unsupported assertion. The TPC analysis predicts more private savings and therefore cannot simply assume deficits “would crowd out investment.”

78% of Trump Tax Cuts Are for Businesses - not Individuals

The Urban-Brookings Tax Policy Center produced some estimates of the tax revenues supposedly lost by the most recent (September) Trump tax plan, which raised the top tax rate from 25% to 33%.  

These estimates are being widely misunderstood by the Wall Street Journal, New York Times and others, so it may help to actually see the TPC 10-year totals organized by tax changes proposed for individuals, corporations and pass-through businesses. 

The estimates themselves are questionable as are related estimates of the distribution of tax cuts by income groups.  I will deal with those issues in separate posts.  

What most needs emphasizing at this point is that although reporters are writing as though the Trump package is about personal income tax cuts, that only accounts for 22% of the estimated revenue loss (relative to bloated CBO estimates).  Moreover, the 10-year $1.5 trillion loss of revenue from modestly lower individual income tax rates is much smaller than estimated revenue increases from repealing personal exemptions ($2 trillion) and capping itemized deductions ($559 billion).  

The only significant net reduction in taxes on non-business income is from (1) repeal of the alternative minimum tax ($413 billion), and (2) more than doubling the standard deduction ($1.7 trillion) – neither change being of any help to top-income taxpayers. 

Wilbur Ross Is Wrong About the TPP’s Back Door for China

In a recent CNBC interview, Donald Trump’s pick for Commerce Secretary, Wilbur Ross, explained why he thought the Trans-Pacific Partnership was a “horrible deal.”  His main complaint was that the agreement has “terrible rules of origin.”  Specifically, he warned, “In automotive, a majority of a car could come from outside TPP, namely could come from China, and still get all the benefits of TPP.”  Presumably this is what Trump was talking about when he said China would “come in … through the back door.”

All trade agreements have rules of origin that specify how much of a product’s manufacturing has to occur within a member country for it to qualify for tariff preferences.  These rules differ from product to product and are the result of negotiation and industry pressure.  Under the TPP’s rules of origin for automobiles and most auto parts, at least 45% of an import’s value must have been created within one or more TPP members for the good to qualify.

So, technically, Ross is correct.  A hypothetical car could contain 55% Chinese content and still be eligible for TPP preferences as long as all the rest came from Japan, Mexico, the United States, or some combination of TPP members.  What Ross is missing, however, is why this is a good thing.  

For one thing, liberal rules of origin help alleviate the problem of trade diversion.  Reducing protectionist trade barriers removes artificial impediments to economic growth by enabling greater specialization that relies on a country’s comparative advantages.  But trade agreements only remove barriers between some countries, leaving others in place.  When all countries’ exports are burdened equally, investment still flows to where products can be made most efficiently.  Tariff preferences, while better than no liberalization at all, have the downside of incentivizing investment based on where there are preferences, creating their own sort of inefficiency.

Ross himself alludes to this problem in his CNBC interview when he notes that “Mexico has 44 treaties with other countries that make it very advantageous to do international shipping from Mexico rather than from the United States.”  But if the rules of origin in Mexico’s treaties allow for high levels of non-Mexican content, some of those goods shipping out of Mexico might be largely made in America.  Mexico’s treaties could benefit American companies that use Mexican parts just as the TPP could benefit Chinese companies that use American parts.

Strict rules of origin, on the other hand, threaten to interfere with cross-border supply chains.  With or without trade agreements, the fact is that many industries have expanded beyond national borders.  Any automobile purchased in the United States, regardless of brand, is going to have lots of foreign-made parts.  The manufacturing process from raw material to pickup truck involves the labor of people in countries all around the world.  The phenomenon of global supply chains unlocks new levels of comparative advantage—instead of car-making, the relevant activities are things like engine-making, glass blowing, software design, and assembly.  Each part of the process is more valuable if the other parts are done as efficiently as possible.  U.S. autoworkers are more productive (and therefore better compensated) when these supply chains are not hindered by tariffs.

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Taxpayers Right-to-Know Act

Cato’s forum on Capitol Hill yesterday featured Senator James Lankford of Oklahoma. The senator mainly talked about his Federal Fumbles report, but he also mentioned his proposed “Taxpayers Right-to-Know Act.”

The legislation complements the priorities of President-elect Trump who complained about “waste, fraud and abuse all over the place,” and promised “we will cut so much, your head will spin.” To know where to cut, Trump and his team will need to learn about hundreds of programs and determine which ones are the biggest failures.

The Trump team can study DownsizingGovernment.org for spending cut ideas. But it would be also useful if the Office of Management and Budget (OMB) provided better information about each federal program.

That’s the thrust of Lankford’s Right-to-Know Act. It would “require OMB to list all [federal] programs, their funding levels, the number of beneficiaries of the programs, and link each program to all related evaluations, assessments, performance reviews, or government reports.” On its website, the OMB would also list the statutes authorizing each program and the number of federal employees, contractors, and grantees who administer them.

Transparency reforms should be extended to the websites of all federal agencies. I’d like to see agencies highlight on their homepages auditor reports on the performance of each program. I’d like to see the “About” pages on agency websites discuss both the pros and cons of agency activities, and not just present one-sided visions. I’d like to see federal agencies provide detailed cost-benefit analyses of each one of their spending programs.

Federal agencies work for us. We pay the bills. Agencies should inform us about their failures as well as their successes. Lankford’s legislation would be a step forward, but more needs to be done. 

Does Higher Ed Prove We Need Bigger, Stronger Gates?

With school choice advocate Betsy DeVos slated to become the next U.S. Secretary of Education, the battle between regulation and freedom has suddenly become more intense, with people on both sides exchanging fire. Yesterday, Jason Bedrick weighed in against regulation, while today Jeffrey Selingo warns that a major reason “choice hasn’t necessarily led to better outcomes in higher education is the absence of a strong gatekeeper for quality control.”

This sort of assertion strikes me as more an article of intuitive faith than a conclusion based on evidence. If only some well-informed, smart group of experts decided what people could choose, choices would be much better. The problem is that no one has the omniscience to do the job, especially so effectively that the costs of bureaucracy, barriers to entry, and kneecapping of innovation don’t severely outweigh the hoped-for benefits.