Upon his return from Asia, President Trump announced that he planned to work “as fast as possible” to reduce the U.S. trade deficits with the nations he visited. He later tweeted out his excitement about working with fellow Republicans to pass their “GREAT Tax Bill!”
Left hand, meet right hand. Those two goals stand in stark opposition to one another.
The Republican tax cut plan has been justly criticized for worsening both income inequality and the national debt, but the plan has another big problem: It’s likely to lead to more outsourcing of U.S. jobs and a larger trade deficit. That’s obviously a negative for factory jobs and net exports, but it’s also precisely the opposite of what Trump continues to promise to many of his working-class supporters.
First, the tax plan moves to what’s called a territorial system of international taxation, which means the U.S. tax rate on the overseas earnings of U.S. foreign affiliates would become zero. While it’s true these firms can defer taxes on these earnings for as long as they like, they cannot “repatriate” them tax-free to invest domestically or to pay dividends to their shareholders (instead, they invest them in financial markets).
Would not the lower corporate rate proposed by the GOP’s tax plan — 20 percent — preclude this incentive? Unfortunately not, because our multinationals have perfected the art of “transfer pricing:” booking, if not producing, their overseas profits in tax havens with single-digit tax rates, while booking deductible expenses in high-tax countries. Under the new regime, they’d be able to keep up this tax avoidance with the added bonus of sending earnings back home tax free. As international tax expert Ed Klienbard puts it: “Territorial tax systems … reward successful transfer pricing gamers as “instant winners” by enabling the successful U.S. firm to recycle immediately its offshore profits as tax-exempt dividends paid to the U.S. parent.”
Of course, if they invested those earnings here at home instead of using them for share buybacks or dividend payouts, that would help boost domestic production, and perhaps some of that will occur. I doubt it, for two reasons.
For one, firms are already flush with retained earnings — corporate profitability is near record highs — and borrowing is cheap. If they wanted to invest more in productive equipment, plants, or their workers, they could do so. Yet, current investment is lackluster, and that’s not likely to change due to the tax cut (as Trump economic adviser Gary Cohn learned firsthand). A recent survey that asked corporate executives what they’d do with a tax windfall found their top three uses of the money were to pay down debt, buy back their stocks (to boost the price), and do more mergers.
In fact, we’ve tried this experiment. Back in 2004, we allowed multinationals to repatriate deferred earnings at a sweetheart rate of 5 percent. They said they’d invest and create jobs with the money, but instead, they laid workers off and shared the tax break with their shareholders.
In other words, the shift to territoriality does not dampen the existing incentives in our corporate code to offshore jobs. It exacerbates them, which will lead to more overseas production and the loss of jobs here at home. As tax professor Rebecca Kysar observed: a “pressing goal of tax reform is to reduce the incentives for companies to move their operations overseas. [This] bill does the opposite.”
Interestingly, the tax writers recognized the problem and tried to fix it with a tax penalty for transfer pricing. The alleged patch incentivizes even more offshoring, creating, according to New York Times reporter Patricia Cohen, “new opportunities for small and medium-size firms to use tax havens to slice their tax rate in half.”
Next, if you’ve followed this debate, you’ve heard about the administration’s implausibly large estimates of economic growth allegedly triggered by their plan. What you may not have heard — they don’t like to talk about this part — is these growth effects depend on large capital inflows leading to larger trade deficits.
The big corporate tax cut is expected to raise the after-tax return on capital investment, and this is expected to draw in capital from abroad. These flows increase the U.S. capital account — basically, investments from outside the country — whose the flip side is the trade deficit. For every dollar the capital account goes up, the trade deficit must get a dollar more negative.
To be clear, a higher trade deficit doesn’t have to be a drag on growth if other parts of the economy are picking up the slack. It will unquestionably hurt our manufacturers, as the capital flows put upward pressure on the dollar, making our exports less price competitive. If you believe the magnitude of these flows as implied by an estimate from the conservative Tax Foundation, their impact would lead to trade deficits twice as large as today’s, implying the loss of millions of manufacturing jobs.
For the record, most economists, myself included, do not believe these magnitudes. But especially given the tax plan, by significantly raising the budget deficit, is sure to reduce national savings, the basic dynamics of the above scenario — increased capital inflows and a larger trade deficit — will likely occur.
We are thus left with a plan that lavishes most of its benefits on the wealthiest households, including the heirs of the richest estates, raises taxes on millions in the middle class, adds over $1 trillion to the debt, increases the trade deficit, and, relative to the current system, ratchets up the incentives to offshoring production and jobs. In its latest iteration, it could also now lead to 13 million people losing health coverage.
It should escape no one that President Trump, who assures us the plan is a “middle-class miracle,” was elected in part by working class voters who believed he would find policies to achieve the opposite of every one of those outcomes, especially regarding trade deficits and manufacturing jobs. In other words, it’s impossible to exaggerate the extent of the betrayal of the working class embedded in this plan.