Health Care “Reform” and Tax Cuts for the Rich

Kevin Drum spots a rare bit of honesty from Rich Lowry:

It’s easy to see things like the Carrier deal, the jawboning of the likes of Boeing, and the saber-rattling against China on trade being quite popular, at the same time the truly big things happening in Washington aren’t, such as Obamacare “repeal” without a replacement, a deficit-increasing traditional Republican “tax cut for the rich,” and even — although this is much less likely — Medicare reform.

Lowry not only admits that the GOP tax agenda is tax cuts for the rich but he also concedes that this may increase the deficit if not offset by things like “Medicare reform” which is not reform but repeal. Of course Lowry also penned something on repealing Obamacare. As Brian Faler notes:

The big winners in Republican plans to repeal Obamacare are likely to be the rich. Rescinding the Affordable Care Act means not only taking away health coverage from some 20 million Americans. It also means scrapping two big tax increases Democrats imposed on the wealthy to help pay for it all.

That is the entire GOP agenda – more tax cuts for the rich.

The Accidental Conspiracy Theorist

All play and no work makes Paul Krugman a tinfoil hat conspiracy theorist.

What is Krugman's implicit assumption in the above tweet? That 9/11 was a false flag operation? That Donald J. Trump is not merely an untrustworthy demagogue but a ticking time-bomb? Can you see why implicit assumptions attributed to someone by somebody else are not valid?

Nearly 20 years ago, in an essay titled The Accidental Theorist, Krugman wrote:

Greider's theorizing is all the more speculative and simplistic because he is an accidental theorist, a theorist despite himself--because he and his unwary readers imagine that his conclusions simply emerge from the facts, unaware that they are driven by implicit assumptions that could not survive the light of day.

Greider's "accidental theory" was the infamous lump of labor fallacy -- the supposed implicit assumption that "there is a fixed amount of work to be done in the world, so any increase in the amount each worker can produce reduces the number of available jobs."

The Current Account Deficit: Low National Savings Redux

I have been reading something Lawrence Summers wrote over 12 years ago. A lot of interesting comments but let me pick out one key segment:

Tautologously, a current account deficit is the difference between national savings and national investments; or, equivalently, between net national savings and net national investment, removing the effects of depreciation. It is natural to look at the U.S. current account deficit and ask whether its level and its deterioration is better attributed to increased investment or to reduced saving. In the last year, the net national savings rate of the United States has been between 1 and 2 percent.

Taking a look at this source and updating what Summers said for 2015, it seems net investment was only 5.5% of NNP. With the trade deficit running at about 3.75% of GDP, net national savings is still only 1.75% of NNP. As Brad DeLong notes:

Let me disagree a bit with Paul: although evidence does suggest that we are near full employment, we are not at full employment--and the suggestion that we are near full employment is a very weak one

Brad was responding to Paul Krugman who also noted:

Trump deficits won’t actually do much to boost growth, because rates will rise and there will be lots of crowding out. Also a strong dollar and bigger trade deficit, like Reagan’s morning after Morning in America.

With a national savings rate of only 1.75%, we should not repeat the mistake of 1981 giving the rich another massive tax break which would further reduce national savings and make the trade deficit worse. We should instead think in terms of how to get investment demand – be it public infrastructure or private investment – higher. As Brad notes, lower interest rates and infrastructure investment would be good policy.

The Passing Of Thomas C. Schelling

Tom Schelling died yesterday at age 95. Serious people argue that by arguing behind the scenes for his Nobel-Prize-winning idea of a focal point that there be no first use of nuclear weapons he was more responsible than anybody else for the fact that we did not have a nuclear war during the Cold War, a period during which on several occasions we came much closer than most people realized.  Unfortunately it seems that with his death we seem to have moved into an era in which his old norm has broken down, and people ranging from some around the current president of Russia as well as his great fan, the president-elect of the Untied States, have taken to talking loosely about such use of nuclear weapons.  This is the greatest single worry I have about the near future, and I suspect that it was shared by the late Thomas C. Schelling.

I attach a link here to a post I made about him and this issue at much greater length back in August.  At that time I announced that he would be making a speech at James Madison University on September 14.  I believe he wanted to make that speech, and confirmed that he would a few weeks before it, only to have his wife send me a message a few hours later stating that he would be unable to due to health reasons. Clearly those health reasons were serious, and I deeply regret his passing.  He was a kind and humble as well as very wise man, for all his brilliance. The world will miss him.

Barkley Rosser

Slavery and Capitalism Redux

The Chronicle of Higher Ed has a piece on the ongoing tussle between quantitative economic historians and “historians of capitalism” over a recent spate of books claiming that slavery was crucial for the development of capitalism—especially The Half Has Never Been Told by Edward Baptist, but also Empire of Cotton by Sven Beckert.

First a disclaimer.  I read Empire of Cotton and found it wonderful.  Not every page convinced me, but the depth and sweep of the research was awe-inspiring, and the overall story (as I interpreted it, more on this in a moment) seemed right to me.  I put down The Half well before I had read half.  It was tendentiously written, with more concern for political performativity than argumentation, and it was obvious that Baptist was prone to error and exaggeration.  The last thing I’m looking for in a history treatise is an unreliable narrator.

The main point I want to make here, however, is that the Chronicle serves us a false dichotomy, either a history informed by culture that explains the inner logic of capitalist development or a reductionist, statistically-driven exercise in model-fitting that adheres to a rather narrow conception of science.  Either we infer from the sequence of events by which slavery in its later stages coevolved with capitalism the intrinsic necessity of that process, or we test counterfactuals to determine whether capitalism could have emerged in a hypothetical world in which slavery had never existed.

No and no.

The core problem here is reification, treating both slavery and capitalism as if they were discrete, homogeneous things instead of rather loose categories we assign to social and economic systems that differ across a multitude of dimensions.  Would some form of capitalism have developed in the US and other countries without the contributions of slavery?  Almost certainly.  Would it look and feel just like the capitalism we have today?  Almost certainly not.

From this perspective, Beckert’s superiority over Baptist is obvious.  Baptist does argue that slavery was essential to capitalist development, while Beckert, if you read him carefully, doesn’t.  In fact, Beckert’s story is one of constant improvisation and experimentation as the conditions for a global-scale market in textile inputs and outputs were painstakingly assembled.  It not only could have happened in other ways; it did.  And it is a mistake to read determinism into Beckert’s account of “war capitalism” (an unfortunate phrase), in which the use of imperial force and direct labor coercion were commingled with market formation, as if the entire history of trade embedded in force (the Vikings, anyone?) had never existed, and early modern capitalists could simply invent an economic order from scratch.

I’ll sign up as a loyal devotee of model-fitting and a student of the contingency of human history embedded in a cultural nexus.

Incidentally, I’m struck by the willingness of people who should know better to defend Baptist.  (The two examples of his methodological errors cited in the Chronicle piece are devastating.)  My hunch is that this is a product of the “good begets good” heuristic, or more precisely its “bad begets bad” corollary.  People have a tendency to think that if something is good it is good in all respects, and similarly if something is bad.  Slavery is bad.  Left historians want to argue that capitalism is bad.  Therefore, showing that slavery begot capitalism demonstrates that capitalism is bad.  Of course, logically it’s all nonsense: good can beget bad and bad can beget good, as they do all the time.  If the purpose is historical understanding, however, the issue is not good or bad, but how and why.

Two Things to Keep in Mind about Allegations of Russian Interference in the US Election

This weekend we’re being treated to claims the CIA is convinced the Russian government used its hacking prowess to support Trump’s election this year, along with equally vehement claims that, in the absence of publicly provided evidence, we have every reason to be skeptical of US intelligence assertions.

Do I have any more access to the intelligence backstory than you do?  No.  But from what I do know, I suggest two starting points for making sense of this tangle.

1. To the extent they have evidence for their claims, US intelligence agencies are unable to reveal them.  The specifics of this evidence would make it clear what methods were used to obtain it, which would make those methods worthless from that point on.  Moreover, the techniques for acquiring defensive information on how US sites have been hacked are largely the same as those used for the US hacking of foreign sites.  If the disclosures were only defensive in nature, a stronger case could be made that it is in the interest of the intel folks to come clean, but they are unlikely to disavail themselves of offensive weapons.

2. Security breaches of the type exemplified by possible Russian hacking of the RNC, DNC and other sites are likely commonplace; they certainly occur much more often than reported.  (It is not in the interest of hacked entities to publicize this fact unless their hand is forced.  They may not even know it has happened.)  Before we bewail our victim status, however, we should note that the US government, and private and semi-private actors in the US, play this game like everyone else.  In the end, if the allegations about Russia are true, what we have experienced in this country is a PSYOP action not so dissimilar in intent and effect from similar actions launched from here.

I’d like to see a debate over whether aggressive exploitation of foreign cyber vulnerabilities by US agencies comes at the expense of domestic cybersecurity and the security of the overall transnational system.  The US has enjoyed first mover advantage in many areas of weaponized technology, but the long term consequence is, or will be, that these methods will eventually return to threaten us.

Comic Book Hayek:The Planners Promise Utopia

In his neo-Confederate "Mein Kampf," Whither Solid South, Charles Wallace Collins quoted a full paragraph from Hayek's The Road to Serfdom regarding the emptying out of the meaning of words.

My instinct would be not to condemn Hayek for the politics of those who quote him. Even the Devil quotes Shakespeare.

But after taking another look at the Look magazine comic book edition of Hayek's tome, I realized that Collins's depiction of full employment as a sinister Stalinist plot was, after all, remarkably faithful to the comic-book version of Hayek's argument. With only a little digging, one can readily infer that what the comic book refers to as "The Plan" is a policy also known as full employment (or, if you want to get specific, William Beveridge's Full Employment in a Free Society). "Planners" translates as cartoon Hayek's alias for Keynesian economists and their political acolytes.

Goldman Sachs Economists Critique the Auerbach Tax Proposal

In my latest comments on Auerbach’s Destination-Based Cash Flow Tax, I noted how it was indeed trade distorting. It seems a lot of its proponents virtually concede this. It also seems that economists Goldman Sachs have drawn the appropriate conclusion:

Under an idealized version of the transition, the dollar would appreciate enough to offset the impact of the tax change, resulting in no impact on prices, margins, or trade flows. Even in this case, a large and abrupt change in exchange rates would deliver a sizeable hit to US residents’ foreign wealth and could create risks of dollar-denominated debt problems abroad. An alternative transition scenario featuring partial dollar appreciation, higher inflation, a hit to the profit margins of US net importers, and higher net exports appears more likely. Industries with low margins and high import shares such as apparel would be particularly vulnerable to the change.

The “idealized version” is that standard proposition of the Mundell-Fleming model that trade protection under floating exchange rates would have no net effect on net exports. Of course the transfer pricing implications are a bonus for highly profitable US based multinationals who want to do massive income shifting and declare it all “perfectly legal”. This is a horrific idea which should not become law.

Boeing, Trade Policy, and Trump Tweeting

Kevin Drum is not happy with Trump’s crony capitalism and he graphed the negative hit on Boeing’s stock price after one of his tweets. Apparently this story sent Trump tweeting as it covered some wise comments from the Boeing CEO:

we recognize the vital role IMA plays in reminding regulators, elected officials and the general public about the important—and indispensable—role American manufacturing has in sustaining the U.S. economy and exports, driving innovation and technology, and creating good jobs. This is a topic I’m particularly passionate about because I see it firsthand each day at Boeing, where more than 138,000 U.S.-based employees are hard at work, designing and building some of the world’s most advanced and innovative products—which are in turn sold to customers around the world….Today at Boeing, international sales represent a large and growing percentage of our business….As recently as 2000, only about 35 percent of our commercial backlog was from customers outside the United States. Today, that number is nearly 75 percent….These numbers are even more impressive when you consider that 90 percent of our total workforce and 80 percent of our suppliers are based here in the United States. International sales have helped Boeing become the country’s largest exporter and in turn help support more than 1.5 million American aerospace sector jobs. Admittedly, Boeing, by the very nature of what we do is more global than the average company, but the same trends apply across industries…In the same way that international sales continue to grow as a percentage of our business, so too will competition from abroad. I fully support competition because I believe that it makes us better. There’s no question that Boeing is a stronger, more efficient and innovative company because of fierce competition from our European rival Airbus. And we face increasingly stiff competition from other countries such as Canada, Brazil, China and Russia who are eager to secure a piece of the large and growing aerospace market. However, to compete and win globally we need government’s support to help ensure a level playing field.

He follows this account of his company with a plea not to pursue various policy positions that impact Boeing’s ability to compete abroad. First a brief review of Boeing’s 2015 10-K and then some of my own comments on the trade issues. Boeing’s revenues exceeded $96 billion with pretax income just over $7 billion. Note 21 provides revenues by region. Just over 40% of this revenue is from US customers with 27% of this revenue from Asian customers including China (almost half of the Asian total). Boeing also derives about 12.75 percent of its revenue from Europe and about 11.25 percent of it from the Middle East. Its effective tax rate was only 27.7 percent but that is because Boeing receives R&D and manufacturing tax credits. Only 4.6 percent of its income is sourced abroad. Boeing indeed a US manufacturer that has extensive foreign customers. I’m no fan of the Ex-Im bank, which strikes me as engaging in trade wars. I’m not also a fan of high defense spending. But we should all be wary of starting a trade war with nations like China lest their take their business to Airbus or even decide to start their own company making aircraft. Another thing that concerns me is the macroeconomic mix. If we repeat the mistakes during Reagan’s first term – higher defense spending and tax cuts for the rich combined with a monetary policy that drives up real interest rates – then the dollar will appreciate which will hurt the sales of companies like Boeing. Josh Marhsall covers Trump’s official excuse for the tweet:

This morning Donald Trump lashed out at Boeing claiming its budget for the successor to the current Air Force One is wildly overpriced….According to Politico, the current Pentagon budget for not one but two planes is $1.65 billion.

While $800,000 (thousand - thanks PeterK) for each 747 might seem expensive to some, is Trump suggesting we let the French build these planes? Or maybe he wants to let a new Chinese airline sector submit a bid.

The Auerbach Tax: Trade Distortion and Transfer Pricing

Alan Auerbach may be pulling a bait and switch here:

Unlike tariffs on imports or subsidies for exports, border adjustments are not trade policy. Instead, they are paired and equal adjustments that create a level tax playing field for domestic and overseas competition; Border adjustments do not distort trade, as exchange rates should react immediately to offset the initial impact of these adjustments. As a corollary, border adjustments do not distort the pattern of domestic sales and purchases

He is saying this in context of his Destination Based (DB) Cash Flow Tax (CFT). His claim on transfer pricing are getting some attention from the international tax law crowd:

Border adjustments eliminate the incentive to manipulate transfer prices in order to shift profits to lower-tax jurisdictions; and Border adjustments eliminate the incentive to shift profitable production activities abroad simply to take advantage of lower foreign tax rates.

I was bothered with this claim as was a November 18, 2016 discussion in BNA’s International Tax Monitor:

The new destination-based cash flow tax would likely change transfer pricing overnight, as incentives to shift high-cost intangibles overseas would be heavily negated. They would require a new look at U.S. tax treaties with permanent establishment clauses, and would cast new light on the OECD’s project to combat tax base erosion and profit shifting, as one of its key participants moves away from the arm’s-length principle and toward a system similar—though hardly identical—to formulary apportionment. The hybrid nature of the proposed tax has left many wondering if it will run afoul of World Trade Organization rules against border adjustments for income taxes—an issue the blueprint itself addresses, claiming that as a cash flow-through tax it wouldn’t apply... The simplicity of taxing income based on the location of sales is one reason why many critics of the current system look to the proposal with some wary optimism.

I think the real issue here is that this proposal smooshes together two very different ideas sort of like how shimmer was a floor wax and a dessert topping. Auerbach has been pushing a tax on economic profits instead of accounting profits for a long time. But typically profits taxes are sourced based not residence based. Now it is true that developing nations don’t like the idea of paying royalties to developed nations so they have favored residence based approaches but the OECD has favored sourced based approach to taxing income. Then again, a company like Apple neither declares its foreign based income in the US or in China but in places like Bermuda, which is why they make like Auerbach’s idea, which was my point here:

The House GOP proposal would effectively say we do not get to tax these profits. And yes I know that Apple has found a way to get all these profits sourced to Bermuda anyway. But this was the whole point of Senate hearings on May 21, 2013.

Sales taxes on the other hand are often DB although there may be exceptions. Excise taxes such as those on tobacco or medical devices are DB. And as I noted there may be transfer prices depending on how the excise tax is precisely administered. Auerbach can claim DB sales taxes do not distort trade but this does not hold for DB profits taxation. Permit me to expand upon this discussion:

Let’s take the Tax Foundation’s first example: “So if a business purchases $100 million in goods from a supplier overseas, the cost of those goods would not be deductible against the corporate income tax.” The foreign profits on those goods would be taxable so how do the proponents of this idea address the prospect of double taxation? Of course a Canadian manufacturer would be tempted to price their goods at production cost so as to have no Canadian taxable income. That would eliminate the double taxation but no sane person would think the Canadian Revenue Agency would accept this non-arm’s length transfer pricing.

Let’s do so by considering Trump Toaster Ovens (TTO) which are a hit in Michigan and are sold by Detroit Distributors but are manufactured in Canada by Windsor Warehouses –both of which are owned by a Toronto based holding company run by Tiffany Trump. TTOs sell for $125 a piece with the cost of production being $80. They are shipped across the Ambassador Bridge to Detroit Distributors which incurs $20 in operating expenses. Total profits are $25 per oven with 80% going to the Canadian affiliate if the intercompany price is $100. US tax rates are now 35% and Canadian tax rates are close to 25% so with no repatriation tax involved (Canada is a territorial system), the effective tax rate is 27%. While currently Tiffany might want to raise the intercompany price – she knows the IRS could object. Of course Auerbach’s DBCFT would change her incentives as she might want to lower this price to only $80 to eliminate the Canadian income tax – assuming the Canadian Revenue Agency does not object. What’s going on here? Auerbach admits:

System is equivalent to the combination of 1. A broad-based consumption tax (e.g. a retail sales tax or a VAT) 2. An equal rate subsidy to payroll

In effect, we would repeal the corporate profits tax for multinationals but then give them a payroll subsidy. Whether this violates current WTO rules, it certainly is a distortion facing sourcing production in Detroit over Windsor. Maybe Trump might like this idea but this is precisely because he wants to use tax policy to shift production away from foreign sources and back to places like Michigan.

From Full Employment To "Inclusive Growth"

This is the third of three posts on full employment. The unifying thread is that "full employment" has always been a political and not an economic problem. The first two posts were The Electoral College, White Supremacy and Full Employment as "Reign of Terror" and Full Employment and the Myth of the General Strike. 

Employing Sorel's distinction between myth and utopia, full employment has always been a utopia. But it is a utopia long abandoned by economists, who have substituted the totem of economic growth for the utopia of full employment.

The term "full employment" did not appear in the speech given today (December 5) by Mark Carney, Governor of the Bank of England. Instead, he mentioned the term "inclusive growth" six times.

"The cry for more inclusive growth starts with a crisis of growth itself."

Noonan v. Cochrane on JFK’s 1962 Jawboning of Big Steel

When I was in graduate school, one of my favorite seminars featured Walter Heller telling us about his days at the Council of Economic Advisers during the Presidencies of John Kennedy and Lyndon Johnson. Every time I had to endure a course in business writing, I recalled a marvelous story from Dr. Heller who was very good as clear and concise writing. While Kennedy enjoyed chalk and talk discussions of the multiplier, LBJ was more of a CEO President who abhorred staples in memos as any memo that got to his desk was only one page long. It seems Treasury had a habit of writing 3 page memos which meant the chief of staff wanted the CEA to condense these memos. Heller at first was insulted at these requests but then realized that this put his team in an incredible position of controlling economic advice that the President received. Heller was my source for this:

The big Keynesian fiscal experiment was that 1964 tax cut, which did seem to work fairly well as the economy returned to full employment by late 1965. While Paul and I were both too young in 1965 to have been included in the discussions between the Council of Economic Advisors and President Johnson, I have had the pleasure of hearing from those who were what kind of macroeconomic advice the CEA gave the President during December 1965. Realizing that the economy was at full employment and seeing the triple whammy of tax cuts, proposed Great Society domestic spending, and the run-up in Defense Department spending from the Vietnam War, the CEA strongly urged the President to push for fiscal restraint lest the Federal Reserve would have to raise interest rates to choke off excessive demand. The President fired back that the Great Society was important to him and that he was not ready to pull out of Vietnam. The President also noted that getting a reversal of the 1964 tax cuts would be politically difficult. The Federal Reserve did raise interest rates in 1966 leading to the 1966 Credit Crunch, which held inflation at bay. However, the Federal Reserve later reversed course unfortunately. So we eventually got a delayed and lukewarm version of the fiscal restraint that the CEA recommended way back in late 1965 – as Paul noted. Too little and too late. For Schlaes to blame the run-up in inflation on the Keynesian economists that advised President Johnson only shows she has absolutely no clue.

I recount this because a couple of conservatives are getting the discussions of the 1960’s a bit wrong again. John Cochrane is not happy with the latest from Peggy Noonan. He notes the following from her WSJ op-ed:

It was 1961 and the new president, John F. Kennedy, had been trying to signal to big business that they could trust him.. His impulses were those of a moderate of his era: show budgetary constraint, keep costs and prices down, prevent inflation.....That September Kennedy asked the industry to forgo a price increase. He asked the steelworkers union for wage demands... Early in 1962 his labor secretary, Arthur Goldberg, put together a deal. In the spring the union and the steel companies accepted it. Everyone understood the industry would not raise prices. A few days later Roger Blough, chairman of the board of mighty U.S. Steel, asked to see the president. He handed him a four-page mimeographed statement announcing his company would raise steel prices $6 a ton. ...Soon Bethlehem Steel raised its prices. Other companies followed. Now Kennedy was enraged. Accepting Blough’s decision would undo all his wage-price guideposts. It would also constitute a blow to the prestige of the presidency. And labor would never trust him again.

He noted more of her op-ed to point out that Noonan claimed that Kennedy’s jawboning was good policy to which he argued:

No, Peggy. Crucially, he was wrong on the policy. No, we do not fight inflation by jawboning companies and unions not to raise prices. That does not "benefit the American people." This isn't fancy economics. Leaders from Emperor Diocletian to Nicolás Maduro have tried to quell inflation by muscling businesses -- sending police to terrorize businessmen in their homes -- not to raise prices, and it always ends with more muscle and more inflation -- as Kennedy's did. He may have "thought" he was right. His Keynesian advisers had also forgotten lessons of two thousand years of history and thought jawboning an excellent idea. But this is precisely why we have a rule of law -- so that leaders who "think" they are right about the proper level of steel prices cannot wreck the economy.

Alas, Dr. Heller’s seminar did not address this episode so we really do not know what the Council of Economic Advisers said about all of this but so let’s try this:

The Democrat, after just a year in office, was concerned about potentially rising inflation. His administration set an informal but well-publicized target of having wage increases and price hikes match productivity increases. Meanwhile, Steelworkers’ bargaining over a contract with the nation’s steel companies was getting nowhere. The administration intervened. It didn’t want a rerun of the 4-month steel strike of 1959 under GOP President Eisenhower. Labor Secretary Arthur Goldberg, a longtime union counsel, mediated the talks. The two sides reached agreement on March 31. The pact, with ten of the nation’s 11 steel companies, called for an increase in fringe benefits worth 10 cents an hour in 1962, but no wage hikes that year. Then-AFL-CIO President George Meany said that in the pact, the union “settled on a wage increase figure somewhat less than the Steelworkers thought they would get.” Kennedy praised the contract as “obviously non-inflationary” and said both the USW and the steel firms showed “industrial statesmanship of the highest order.” The agreement also implicitly said the companies would not raise prices, as that would be inflationary. But on April 10, Roger Blough, CEO of U.S. Steel, the largest of the firms, with 25% of the market, met Kennedy in the Oval Office and told him the company was immediately raising prices by $6 a ton – and that other steel companies would follow. Six did. The 3.5% hike enraged the president. What he said in public was biting – but he was even more caustic in private.

Arthur Goldberg was a labor lawyer representing the United Steelworkers of America before he became Kennedy’s labor secretary. So why did Ms. Noonan note that this episode was part of the negotiations of this union and big steel? Maybe Noonan does not want to bring up the issue of wage floors and monopsony power. I threw in my two cents but please read Noah Smith. It strikes me that the market for steel workers in the 1960’s was more akin to the monopsony model than perfect competition, which is why we needed a steel workers union.

A Left-Right Convergence on More Child Labor

A few months back I reported on the movement of leftists to repeal or at least pare back child labor laws worldwide.  Hostility to child labor is understood by these people to be eurocentric, patriarchical and aligned with the labor market needs of modern capitalism—and therefore wrong.  Instead we are encouraged to support working children, and what these children tell us is they want to work.  So away with the restrictive laws.

But you don’t have to be on the left to endorse more child labor.  Here’s Joseph Sunde of the hard-conservative Acton Institute with a similar message.  Note the emphasis on the psychological benefits children are supposed to get from being productive; this is the same argument made by the left.  Similarly, the benefits of child work as a preparation for adult life figure strongly on both wings.

I’m reminded of the affection for Hayek shown by Foucault in his final years.

Border Adjustments and Transfer Pricing – the Case of iProducts

I promised to mull over the Auerbach and Holtz-Eaton claim that the House GOP’s Destination-Based Cash Flow Tax would eliminate the need to enforce transfer pricing and the answer is contained in the proposal under “border adjustments”. As the Tax Foundation notes:

In the context of a value-added tax, a border adjustment works by applying the tax to imports, but exempting exports from the tax. The GOP’s business tax is not a VAT, but the mechanism that makes it border adjustable is similar. In order to make the corporate tax border adjustable, the revenue from sales to nonresidents would not be taxable, and the cost of goods purchased from nonresidents would not be deductible.

This is an unbelievably bad proposal at some many levels. Let’s take the Tax Foundation’s first example:

So if a business purchases $100 million in goods from a supplier overseas, the cost of those goods would not be deductible against the corporate income tax.

The foreign profits on those goods would be taxable so how do the proponents of this idea address the prospect of double taxation? Of course a Canadian manufacturer would be tempted to price their goods at production cost so as to have no Canadian taxable income. That would eliminate the double taxation but no sane person would think the Canadian Revenue Agency would accept this non-arm’s length transfer pricing. But let’s have the Tax Foundation give the flip side:

if a business sells a good to a foreign person, the revenues attributed to that sale would not be added to taxable income.

The ultimate tax giveaway! Imagine some firm in Seattle that designs and distributes iProducts for sale here as well as abroad. Apple does not manufacture their products outsourcing production to Foxconn. Let’s assume that Foxconn sells the products for $200 while Apple sells them for $400 - $200 in value-added for Apple and its distribution affiliates. Before we get into the details of taxation, let’s note this early Trump failure:

One of those famed promises of Donald Trump's is that his policies, now that he's President-elect, will make Apple bring back their iPhone manufacturing to America…For all the expensive and really productive parts are already made in the U.S., with a little bit going to Japan. China has just the assembly--and that's such a trivial part of the process that it's simply not something worth worrying about at all.

Tim Worstall is right that Foxconn only assembles iPhones but I think most of the expensive parts are sourced from other Asian suppliers. But at the end of the day, the $200 is an arm’s length price with the income tax revenues going to the Chinese assembler and the Asian suppliers of components. So let’s focus on the $200 per product that goes to Apple. Let’s reasonably assume that the foreign distributors incur $40 per product in operating expense and deserve profits equal to $10 per product under arm’s length pricing. In our story - $150 per product represents the profits attributable to the intangible assets created in Seattle. The House GOP proposal would effectively say we do not get to tax these profits. And yes I know that Apple has found a way to get all these profits sourced to Bermuda anyway. But this was the whole point of Senate hearings on May 21, 2013. This proposal would entirely just give up on combatting Base Erosion and Profit Shifting. At times, I have suggested that certain Republicans in Congress really want to shut down enforcement of section 482. It seems I was correct. Did I say this was a horrible idea?

The Identity-Equals-Causation Fallacy, Yet Again

You’d think a trade deficit would be a trade deficit, but you’re wrong.  For many economists, a trade deficit is actually a capital account surplus in disguise.  Yes, US imports exceed exports, but according to this crowd it is not due to what the US does and doesn’t produce, or the cost or quality of our goods and services, or any other such factor, but simply reflects the net inflow of finance.  First we have policies that cause US financial assets to be more attractive, then we end up with a trade deficit.  This is the “insight” behind the view that bolstering national savings will fix the trade problem.

You can see this machinery at work in Gregory Mankiw’s latest opinion piece for the New York Times, which instructs us, “Don’t Worry About the Trade Deficit”.  It patiently explains that the money leaving the country on the current account (via trade) equals the money entering the country on the capital account (via financial flows), and that the latter drives the former.  The key paragraph reads:

The trade deficit is inextricably linked to this capital inflow.  When foreigners decide to move their assets into the United States, they have to convert their local currencies into American dollars.  As they supply foreign currencies and demand dollars in the markets for currency exchange, they cause the dollar to appreciate.  A stronger dollar makes American exports more expensive and imports cheapers, which in turn pushes the trade balance toward deficit.

So here we have a theory of the relationship between international capital flows and trade: a shift in net financial inflows causes an appreciation of the dollar, which then causes a greater trade deficit.  Where does this theory come from?

The ultimate source is the national income and product identity, augmented by the accounting relationship between savings and consumption.  From NIPA we have

Y ≡ C + I + G + NX

where Y is national income, C is consumption, I is private investment, G government spending (purchases of goods and services by government) and NX is the trade balance.  That “≡” sign means “is identical to”, which is subtly different from simple equality, “=”.  With equality, the stuff on the left hand side has the same value as the stuff on the right hand side.  With identity, the stuff on the left hand side is the same stuff as on the right hand side, just expressed differently.  If A = B, A and B could be different but for some reason aren’t.  If A ≡ B, A and B are two different ways of writing the same thing, so it is impossible for them to be different, even for an instant.

Now let’s add a second identity that represents the truism that all income is either consumed, publicly or privately, or saved or paid in taxes:

Y ≡ C + S + T

with S being savings and T being taxes.  Putting them together, we see that

C + I + G + NX ≡ C + S + T

Subtracting C from both sides and rearranging gives us

NX ≡ (S-I) + (T-G)

Read this as “the trade balance (net exports) is identical to the sum of net savings (savings minus investment) and the government’s budget surplus or deficit (taxes minus spending).”  This is not a theory of what causes what; it’s an identity, different ways of expressing the same “what”.

How can this be?  An important source of identity relationships in economics is the two-sided nature of economic transactions.  If I pay you $10 for something, this can be seen as $10 of spending (mine) as well as $10 of income (yours).  My spending is not equal to your income; it is your income: one transaction, two ways of recording it.  Add up these identities over a whole economy, subdivide income or spending into different categories, and you get a set of macroeconomic identities.

So now consider what an export or import means.  An export signifies the receipt of income by people in the exporting country but not the corresponding spending.  An import signifies spending without the corresponding income.  So a trade deficit has to take the form of national spending exceeding income, which means net borrowing.  This borrowing can occur either in the private sector (less saving relative to investment) or in the public sector (government borrowing).  And net borrowing on a national scale is what we mean by the capital account, so there we have it.

All of this is in the realm of identity.  There is no causation at work here.  Net exports does not cause net borrowing, nor is it the other way around; they are identical to one another, different ways of recording the same economic events.  Any measured discrepancy would be a problem of measurement, not a problem of whether the identity is true.  (This is an oversimplification, since it leaves out transfers, asset incomes and currency flows.  The main adjustment would be to add transfer payments and net asset income to the current account.  A further adjustment would need to be made for changes in holdings of currency, the reserve account, which is a non-borrowing method of finance.  That would add more algebraic symbols, but it wouldn’t alter the essential logic.)

So now reread the above paragraph from Mankiw.  This is telling a story of causation over time, not identity. First we have increased inflows of finance, then the dollar appreciates, then the trade deficit widens.  The first process could be virtually instantaneous, because currency markets are comprised of exactly these demands for and supplies of foreign exchange.  The second process, however, takes place over months, depending on the shape of the J-curve that depicts the change in trade balances over time in response to an exchange rate shock.  But we know from the identities that the trade balance is identitical to net borrowing at each moment; that’s what it means to be an identity.

The only valid theory of trade deficits and capital inflows would be one that looked at all the determinants of this identity simultaneously.  It would have to consider the factors that determine what goods a country produces, what it exports and imports, the terms of trade, differences in international growth rates and the demand and supply of financial assets.  One way of looking at the current account-capital account identity does not cause the other; the international position of the US economy, which can be measured either way, is caused by the balance of all the influences on trade and finance.  And yes, that includes the choices made by firms in the US to increase or offshore their productive capacity, along with everything else.  The relative importance of these factors is an empirical question, not a theoretical one.

The flaws in Mankiw’s analysis do not come from inaccurate data or a faulty assumption here or there, but a basic misunderstanding of Econ 101.  The guy needs to take an intro class.  Of course, if the textbook isn't very good it won't help him much.