Why do we have a Trade Deficit? & Tax Reform Done Wrong!
STAPLES CONSULTING
MARCH 19TH, 2018
THE GOOD NEWS
DEFICITS ARE WORSENING
TRADE CONNECTIONS
TAX REFORM DONE WRONG
I do need to apologize for missing the last two newsletter deadlines. I’ve been trying to work on writing and getting a book published on economics, history, and religion. (You know a light and easy topic with no controversy at all! :) ) Plus the economic news has been real slow with this new administration.
THE GOOD NEWS
Just some of the good economic news out there.
The United States has continued to experience the longest continuous job growth (private sector jobs) in the modern era (from the end of World War Two): 87 months
We have now gone 157 continuous weeks with jobless claims under 300,000 per week; the United States had not experienced this length of jobless claims since 1970, when the labor force was much smaller.
We have seen the continuation of solid job growth. In 2016 2.2 million new jobs were created in the United States. During 2017 job growth slowed just a bit and added 2.1 million new jobs.
The U3 unemployment rate held at 4.1% in February, its lowest level since December, 2000, for the fifth straight month. The U6 unemployment rate has come down from last summer to 8.2%. (This measure includes part-time jobs seekers or those who are still too discouraged to seek work.) In December, 2000, this rate was at 6.9%; so there is still slack in the job market that should keep inflation pressure from rising too quickly.
We are still experiencing the third longest economic expansion in the modern era, which has lasted 103 months. (By June we will pass the second longest of 106 months, 1961-1969.)
DEFICITS ARE WORSENING
The national debt will shortly hit $21 trillion.
(GDP = Gross Domestic Product)
2014-15 Budget deficit of $439 billion-2.5% of GDP.
(We paid $402 billion in interest payments on our previous debt.)
2015-16 Budget deficit of $585 billion-3.2% of GDP.
(We paid $433 billion in interest payments on our previous debt.)
2016-17 Budget deficit of $666 billion-3.4% of GDP.
(We paid $458 billion in interest payments on our previous debt.)
Est. 2017-18 Budget deficit of $750-830 billion-3.8%-4.2% of GDP.
(A small chance we will hit $500 billion in interest payments.)
Est. 2018-19 Budget deficit of $1-1.1 trillion-5%-5.5% of GDP.
(We will definitely pay over $500 billion in interest payments.)
Another thing to consider is how much more debt is being issued and how much help we need to finance the national debt. During the past five years the Treasury Department needed to issue on average $658 billion in Net Debt issuance per year. To keep pace with the rising shortfall, the Treasury Department will need to raise, on average over the next five years, $1.27 trillion per year.
The President’s recent budget projections have the United States growing at 4% growth over the next 10 years. The question is at what cost? How much more debt can we add on to our future generations before we do great harm to the economy?
In 1995, we hit a post World War Two high of having our debt equal to 67% of the GDP; by 2001 we were able to reduce that down to 57%. This was done by a combination of a long economic expansion (increasing government revenues); three rather large tax increases over the previous two decades; and the holding down of government spending over the past 10 years. There were projections that if we would stayed on the same path over the next 10 years, we could reduce the National Debt down to zero! This would have been the first time since 1836 that the United States would have been debt free. There was even a debate between economists if this was a good idea or not. The big concern was the interest that the United States paid on its debt was always used in finance as the Risk-Free Rate of Return, which was used to evaluate the risk on all other debt. If we didn’t have this as a measure, won’t it destabilize the world’s debt markets?
Well we didn’t need to worry, we chose another path.
We decided that we wanted tax cuts and increased government spending at the same time. Currently the national debt has hit 105% of GDP. If we look back, over the past 18 years the only growth that the United States has been able to generate is by enlarging the national debt. If we break down the growth rate of the United States GDP and compare it to the growth of the national debt as a percentage of GDP, we can see that for every year since 2000 we have had to go deeper into debt to expand the economy. This not a good way to grow the economy, particularly during supposedly good times!
The other problem--who owns our debt? In 1955, foreign investors held no part of the United States national debt. We saved enough as a nation, that United States citizens and corporations were able to loan to the government all the money it needed to finance our debt. By 1975, 16.7% of our debt was owned by foreign investors; this increased to 22.2% by 1995. Today, 31% of our debt is owned by foreign investors. The question that should concern us as a nation, is in the future what demands are these foreign investors going to ask of us, to have them consider to continuously loan us ever-increasing amount of dollars, so that we can go deeper in debt or be able to finance our current debt?
TRADE CONNECTIONS
We seem to be on the verge of a trade war based upon some very bad assumptions. First, let me state at the very beginning, nearly every mainstream economist both historically and present day believes in the concept of Free Trade. Only a small number of fringe pundits believe that trade is a zero sum game, where there are just winners or losers. It is difficult to exaggerate the importance of Free Trade in the modern marketplace. When consumers and producers are allowed to trade over a broader market area, they will be able to produce a larger output and consume a more diverse bundle of goods. Conversely, obstacles that restrict trade, either domestically or internationally, will reduce output, income, and the general living standards of consumers.
The problem with trade is that we can see locally the losers of trade through job loss, businesses moving overseas or closing down entirely. It is easy to blame these losses on trade or even better we can accuse others of trading unfairly, and it is their fault, for our harm.
The benefits of trade many times are hidden in the workings of the marketplace. One of the general benefits is that it allows for specialization in the production of goods and services; through specialization there is an increase in total output. Each nation produces those goods it makes best and then trades with other countries to acquire the goods it desires to consume. A second general benefit is the “economies of scale” where domestic firms will be able to produce larger outputs and achieve lower unit cost than they would if they were unable to sell their products internationally. A third general benefit is that competition from abroad keeps domestic producers on their toes and gives them a strong incentive to improve the quality of their goods and services. All of these contribute to the greatest benefit of trade: that is the slowing of growth in inflation and making goods and services more affordable to domestic consumers. (This benefit is never really seen by the consumer, though.)
There are two very important and big reasons why we have a trade deficit in goods and services in the United States. One is well known and is written about quite often and the other is almost never discussed and more controversial. First, as noted above we have a huge budget deficit and it’s getting larger! One of the better documented and researched subjects is the correlation between a nation that has a large budget deficit and at the same time has a large trade deficit. (Ceteris Paribus.) One way to understand the connection from budget deficits to trade deficits is that when government creates a budget deficit, with some combination of tax cuts or spending increases, it will increase the demand for goods and services by consumers, and some of that increase in demand will result in the buying of goods and services from foreign sellers, increasing the level of imports. A higher level of imports, with exports remaining fixed, will cause a larger trade deficit. That means foreigners’ holdings of dollars increase as Americans purchase more imported goods and services. Foreigners use those dollars to invest in the United States, which leads to an inflow of foreign investment. One possible source of funding our budget deficit is foreigners buying Treasury securities that are sold by the U.S. government. So a budget deficit is often accompanied by a trade deficit.
The second and more controversial reason for our trade imbalance is that we are a high cost society and because of this our businesses are at a cost disadvantage against foreign competitors.
Looking at this problem at the most macro-scale possible, we can see that because our society is high cost, American business has to find other means to compete in the global marketplace. The easiest place to cut cost is in the wages and benefits they offer their labor force. I need to state here, this approach is not widely accepted or even considered by many economists; so it needs to be taken with a bit of skepticism.
If we look at five major areas in the economy and benchmark ourselves as a nation against our major foreign competitors, we are at a huge disadvantage when we try and compete against goods and services produced in these nations. The five areas are healthcare, education, criminal corrections, the military and the process of paying taxes. If we look at these five areas from just measuring their cost and outcomes against our major global competitor nations; we can see that as a society the cost to us is enormous.
We first look at our healthcare system. In the United States we pay over 17% of GDP to cover the healthcare cost as a nation. When we measure this with the overall average against the nations in the OECD (Organization of Economic Cooperation and Development with a total of 35 nations), they pay only 8.5% of GDP to cover their cost and their overall healthcare outcomes are generally better than the United States.
If we look at our education system, we pay 6.2% of GDP to cover the educational cost of the nation. The average for the OECD nations is 4.5% of GDP, and when we compare our K-12 results we come in at the bottom third of these countries.
The best way to look at criminal corrections as a drag on the economy is considering the number of people who are either warehoused in the system or the number of people employed to watch people do nothing in jails and prisons. Currently, we have over 2,000,000 people sitting in jails and prisons and another 430,000 people hired to watch them. We have more people incarcerated in this country than any other country in the world in absolute numbers and comparisons by per capita. If we look to France (a nation with a similar crime rate), and adjust for population differences, they house only 200,000 inmates in their system. This means that we have 1.5% of our workforce producing nothing, gaining no human capital, and will have a more difficult time finding employment once they are released than when they were first incarcerated.
When we look at the total cost of our military including the VA administration and our intelligence gathering agencies, we spend nearly 5% of GDP. Our NATO allies (North Atlantic Treaty Organization) are required to spend only 2% of their GDP on their military. If we look at the top 10 nations that spend the most on their military, the United States is the top spender, and if you add up the next nine nations we outspend them as a group. (Seven of these nations are our allies.)
Finally if you look at the cost of filling out forms and filing taxes, the United States has the most complex and complicated tax system in the world. Our present tax code has nearly 80,000 pages of laws, rules, and instructions. It takes conservatively over 1% of our population working full-time to complete the required forms and keep track of the proper documents for tax filing. In a number of countries around the world, the normal taxpayer will take only 15 to 20 minutes to file their taxes online.
When we add all of these extra costs to our society, we begin to see why our businesses have difficulty in competing in the global marketplace.
The following chart show how far we have to go, to be a globally competitive society. It looks at how much we overpay or lose to idle or unproductive workers.
Health Care 8.5%
Education 1.6%
Criminal Corrections 1.5%
Military 3.0%
Tax Preparation 1.0%
Total 15.6% of GDP
We have a lot of areas to fix to make us more globally competitive, the problem is these currently are not even being discussed seriously.
TAX REFORM DONE WRONG
The recent tax reform bill that was passed by Congress have several areas of concern for me. First, we need to realize that every tax dollar that was returned to Corporations and taxpayers was a borrowed dollar. We will have to find investors who are willing to lend us money, so we can give large tax breaks to corporations and the top 10% of taxpayers. This means every taxpayer today has to pay interest on the money we gave back, it also means that our children and our grandchildren will be paying interest also on this money. And that some future taxpayer will be on the hook to pay back the money we borrowed. This is really not good for anyone.
Second, when we look at the end result with this recent tax reform bill it will create nearly 2,000 more pages of laws rules, and instructions. This is going to do nothing but add more complexity to an already world-beating tax system, which reduces our ability to compete globally.
Thirdly, this tax bill has reinforced the myth that tax cuts pay for themselves. No peer-reviewed study has ever shown that tax cuts create enough new growth to replace the tax revenue that is lost. I continually hear pundits and amateur economists make this claim, but never offering any proof or historical facts to back it up. When doing tax reform we need to stick to the things we can prove, not what we hope will be the outcome.
Respectfully Submitted by: Christian M. Staples 756 Worden Avenue Kalamazoo MI 49048
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