The GOP Tax Plan Will Grow the Economy…and the Trade Deficit Too

A new study from Boston University has some great news for the GOP. According to Boston’s research, the GOP plan for tax reform could increase GDP by as much as 5 percent and wages by as much as 7 percent depending on the year considered.  This translates to almost $4,000 dollars in take-home pay for the average American.  Not only that, but the study found that the GOP tax plan could also be revenue neutral. Meaning all these newfound liberal deficit hawks would have nothing to complain about. Unfortunately, good news usually sometimes comes with bad. The bad news is that according to the same analysis the growth would come from something that President Donald Trump has railed against for years, trade deficits.

Many argue that President Donald Trump’s screeds on the campaign trail about manufacturing and the United States “losing” to foreign countries is the reason he was elected. There is some truth to that. Voters in rust belt states like Michigan and Wisconsin, who have arguably been most hurt by global trade, helped Donald Trump gain the 270 electoral votes necessary to win. Of course, most economists at the time criticized Trump’s arguments as antiquated and noted that the country is overall better off with globalization than without it. This latest study seems to prove these economists right.

The huge GDP growth that the Boston University study predicts comes from something called capital inflows, “…The inflow of foreign capital increases U.S. output and the productivity of U.S. workers. Depending on the year, it raises GDP by 3 to 5 percent and real wages by 4 to 7 percent”

Capital inflows are foreign investment, both real and financial, into a country in the form of increased purchases domestic assets. Capital inflows are calculated as part of something known as the balance of payments.  The balance of payments, without getting too much into the weeds, is basically the balance of money flowing in out of the country. For example, money flows out when we buy goods from China and then it flows back in when China invests in an American company. Give or take a few lopsided currency exchanges the balance of payments is always zero. Hence the word balance. This balance is why so many economists criticized Trump’s arguments against trade. All that money that China gets from us comes right back into the US economy.  This is why the GOP tax plan could enrage Trump and his supporters.

Reducing the corporate tax rate would make America an even more attractive place to invest. This is precisely why President Trump is so strongly behind it. However, as more money flows into the United States fewer goods will leave creating a bigger trade deficit. Harvard Economist, Greg Manikew, explained the inverse relationship in the New York Times almost a year ago,

“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 currency 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 cheaper, which in turn pushes the trade balance toward deficit.”

There are only two ways to get American dollars. Convert currency or sell something to someone who has dollars. As Manikew points out, if a bunch of foreign investors convert their money to dollars this will cause the US dollar to appreciate. The more expensive the US dollar is the less attractive our goods are to world markets. This will cause our trade deficit to increase as fewer countries buy American goods. If foreign investors decide to make products and sell them in American markets as a way to get US dollars the result will be the same.

The details of the GOP tax plan have yet to be released. However, the framework is well known and President Trump is right to support it. Making America a better place to do business is something Trump should tout and demand from Congress. However, making America a better place to do business will exacerbate the very problem that Donald Trump ran against in 2016 and still harps on to this day. President Trump will have to decide if he wants to grow the economy or shrink the trade deficit. There seems to be a direct correlation between growing trade deficits and economic growth. For five decades our economy exploded along with the trade deficit and no one really cared.  Five percent GDP growth more than likely will have the same effect.  At that point, Trump ‘s biggest problem will be if anyone notices his new slogan, Make Trade Deficits Huge Again.

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