In a tightly integrated global economy, no nation can afford to assess a comprehensive tax reform proposal on its apparent domestic merits alone. The Reagan proposal has many virtues, including lowering marginal tax rates and broadening the tax base. It would be an ideal plan for nations with certain characteristics, especially those with a low rate of consumption and a highly competitive business sector. Indeed, the Reagan plan seems ideally suited for Japan.
But the United States, as we know, is not Japan. While Japan is a major exporter of capital, the United States now relies on large imports of capital from abroad. Financing the U.S. balance- of-payments deficit will require an infusion of about $145 billion of foreign capital this year. An even larger amount may be needed in 1986. Left unaddressed, this could well be the nation's most pressing and ultimately destructive problem.
A persistent dependence on foreign capital by a developed nation implies the presence of severe underlying problems. Usually the country is overconsuming (devoting too large a share of its GNP to consumption), is no longer competitive in selling its products in global markets, or both.
Such nations are eventually shunned by global investors, and for good reason. Ultimately these international pariahs experience great difficulty attracting foreign capital. The outcome, if dependence on foreign capital goes unchecked too long, is a drop in currency values, rising inflation and interest rates, and a humiliating loss of international prestige and power.
With this unhappy prospect in mind, the Reagan tax reform proposal must be assessed on its ability to alleviate the U.S. dependence on foreign capital. If it reduced the growing U.S. addiction to imported funds, it would help avoid a catastrophic worldwide decline in the nation's economic prestige and could therefore be judged a constructive plan. If it did the opposite, it would run counter to the nation's long-term interests.
The U.S. dependence on foreign capital stems both from overconsumption and the current lack of global competitiveness among American businesses. The Reagan tax proposal lowers taxes on individuals by 7 percent while raising business taxes 25 percent. This would encourage additional household consumption by giving consumers a bigger share of national income, and would further retard our global competitiveness by raising business costs. It would, therefore, increase further the nation's worrisome dependence on foreign capital. (The version of the bill approved over the weekend by the House Ways and Means Committee would go even farther in that direction.)
In recent years the strong dollar has redistributed income in the United States from the corporate sector to households. Thus corporate profits have been eroded, while household purchasing power has been augmented by the availability of low-cost imports.
As the household share of income has increased, the proportion of GNP devoted to consumption has jumped. From 1960 to 1981 consumer spending fluctuated narrowly between 61 percent and 63 percent of GNP, averaging 62.5 percent. Since 1982 this percentage has averaged almost 65 percent.
Thus the U.S. balance-of-payments problem and the accompanying rise in our dependence on foreign capital are partially attributable to overconsumption in this country. The Reagan tax proposal would cut consumer taxes, raise the share of national income going to households and further increase domestic consumption as a percent of GNP. Thus the proposal would heighten the perception among global investors that the United States is devoting too large a share of its resources to consumption and too little to saving and capital spending.
The current account deficit of the United States has ballooned from $7 billion in 1981 to $102 billion in 1984, and likely will reach $145 billion this year. These deficits must be financed, dollar for dollar, by foreign capital inflows.
Here, too, the Reagan tax reform proposal pushes the United States in the wrong direction, since it would raise business taxes an estimated $20 billion in 1986 and $26 billion in 1987. This increase in business costs would make American corporations even less competitive in world markets and, inevitably, heighten our dependence on foreign capital.
If the Japanese were to adopt the Reagan tax reform plan, they might be able to shrink their embarrassingly large trade surplus, and thereby disarm the world proectionist movement, without having to push the yen sky high. It would raise consumption and business costs in that nation, so renowned for its high savings rate and tough, disciplined business sector.
But while constructive for Japan, any tax proposal that redistributes income away from business toward consumers in the United States invites disaster. By magnifying the twin problems of U.S. overconsumption and declining global competitiveness while simultaneously increasing the nation's dependence on foreign capital and the global investor's perception of U.S. economic weakness, the tax reform proposal threatens to have cataclysmic consequences for the world financial system.
Among other things, the dollar would drop sharply, leading to a severe downgrading of its role as the world's major reserve currency. In short, the Reagan tax reform plan would raise the likelihood of a repetition of the devastating embarrassment and shame that acompanied the plunge in the dollar in the late '70s under President Carter.
Such an adjustment may occur anyway if the United States fails to address what now appears to be an ever expanding balance-of-payments deficit. But there is no reason to worsen this gigantic and as yet unattended problem merely in the interest of tax reform.