Republicans’ tax plans are going to clash headfirst with President Trump’s anti-China, anti-trade-deficit rhetoric. It's just simple economics.
Assuming they pass, Republican tax plans are forecast to increase the federal debt by about $1.3 trillion to $1.6 trillion over the coming decade, though scoring and specifics vary. This is the same debt that, campaigning in Ohio, Trump called “a weight around the future of every young person in this country.” As the debt grew under his predecessor, Trump didn’t mince words:
And he didn't stop once he was elected:
But now that it’s time to pass a tax plan that nonpartisan observers agree will require deficit spending, Republicans are on board with growing the federal debt. Large-scale borrowing will help make up the gap in lower tax revenue while avoiding some painful cuts to government programs.
To cover that shortfall, Trump’s government and its successors will be issuing additional Treasury bonds for decades to come, with Eric Toder, co-director of the Tax Policy Center, posting that one version of the bill would grow the debt as a share of the economy by 6 percentage points by 2017, and 10.1 percentage points by 2037. About half of those bonds will end up being held abroad, according to Joseph Gagnon, senior fellow at the Peterson Institute for International Economics.
Treasury data compiled by the St. Louis Fed shows that foreign central banks, investors and corporations already own $6.17 trillion in Treasury bonds in the second quarter, compared with $5.73 trillion for private domestic investors. More than a third of those international investors are based in two countries: China and Japan.
China, which in combination with Hong Kong held $1.38 trillion in September, is America’s largest foreign creditor, and its role is increasing as it resumed Treasury bill purchases earlier this year.
Those trillions in foreign financing don't appear out of thin air. There's another side to that balance sheet, and it's one Trump likes even less.
How the Republican tax cut could aid foreign competitors and grow the trade deficit
Republicans say the cuts are intended to increase economic and employment growth, but there are many signs the economy is already firing on all cylinders. For example, the unemployment rate is at 4.1 percent, and economists don't think it can go much lower.
Meanwhile, the economy has been growing at 3 percent in recent quarters; economists don't think it can grow much faster (or even maintain that speed for much longer).
A tax cut would inject more money into this fairly hot economy — effectively putting more money into a container that’s nearly full.
“It is going to put quite a bit more money in people’s pockets,” said Gary Hufbauer, a senior fellow and trade expert at the Peterson Institute for International Economics.
The extra money has to go somewhere. Some of it might be saved by individuals and corporations. But the U.S. has a fairly low saving rate overall. That means the money is likely to go abroad — in the form of Americans buying goods and services.
When Americans buy those goods and services, they'll give dollars to foreign countries. Those dollars can then in turn be used to provide loans to the U.S. to finance the tax cut.
This economic cycle increases the trade deficit. Academic research has shown that deficit spending leads to bigger trade deficits. The IMF has found that each additional dollar of deficit spending leads to about 60 cents of trade deficit.
By that math, $1.5 trillion in additional borrowing to fund the tax cut would increase the trade deficit by $900 billion.
Trump's team has tried to explain the contradiction, arguing the tax plan would increase domestic investment in the U.S. and eventually increase exports — attacking the trade deficit from another direction.
“The way we mainly wish to reduce the trade deficit is by increasing our exports as opposed to constricting imports,” said Commerce Secretary Wilbur Ross at the Wall Street Journal CEO Council. “That way you have more total trade and you have a reduction in the deficit.”
Taken alone, the trade deficit isn't a very useful indicator of economic health. A country can thrive even if it's running a deficit and starve during a surplus.
But Trump built a campaign around using trade deficits as a measure of whether America was “winning” or “great.” Now that he's in a position where his policies will have a clear effect on that measure, he's dealing with the reality that some of his promises hurt other ones.