Month: May 2016

Too Few Jobs: Trade Is Not the Problem, Slow Growth Is

Theodore A. Gebhard

[Note:  This post originally appeared in American Thinker magazine on May, 27, 2016.]

The irrefutable evidence of economic history over several centuries is that the wealth of societies (later nation states) significantly increases as trade expands.  Scarce resources are conserved by being able to obtain goods from others who can produce those goods more cheaply.   The conserved resources then become available to be redeployed to other productive activities, thus adding to the total stock and diversity of a society’s wealth.

Notwithstanding this overwhelming evidence, however, expansion of trade is often singled out as detrimental to a society’s well-being.  Presumptive Republican presidential nominee, Donald Trump, for example, has made the alleged “costs” of trade a centerpiece of his campaign.  Mr. Trump cites current account deficits with China and Mexico as evidence that those nations are taking advantage of the U.S. and stealing U.S. jobs.  He says that, if elected, he will use his business skills to renegotiate existing international trade agreements so as to eliminate the deficits and bring jobs back home.

Regrettably, Mr. Trump sees the conservation of resources, especially labor, as a cost instead of a benefit to be exploited to the nation’s advantage.  This view is short-sighted, and it ignores the principal reason for the lack of new employment opportunities for resources that have been freed up because of trade, a near stagnant economy.

Economic systems are highly complex. In a market-based economy, all economic variables, including policy variables, are interconnected.  If you push on one variable, every other variable shifts — some imperceptibly, others measurably.  A consequence is that focusing on a specific perceived problem in isolation nearly always leads to a failure to grasp the actual causes of the problem.  Regrettably, politicians rarely learn this lesson.  As a result, they try to “fix” a specific problem that they can see with cocooned policy that does not account for other variables either unseen or incorrectly perceived to be unrelated.  In the end, the “corrective” policy more often than not does more harm than good.

Mr. Trump’s view about the “costs” of trade suffers from this short-sightedness. It focuses solely on what is visible, the displacement of resources (e.g., jobs) in those industries most affected by trade.  Such a restricted view has great emotional appeal because structural changes owing to trade can cause severe hardship to those whose lives are disrupted, and a compassionate nation should rightly address this result (I will come back to this).  Limiting one’s focus only to what is visible, however, excludes accounting for the benefit, on a macro level, of the nation’s enhanced capacity to grow by reallocating those conserved resources to other productive activities.

In this regard, a nation is no different from an individual. Most individuals find that it is cheaper to buy groceries at a supermarket than to produce their own food.  Because it is cheaper, money is conserved that then can be spent on other items that enrich one’s life.  Similarly, a nation that buys goods from abroad at a cost less than it would incur producing those goods at home can use those savings to expand output in other areas.  Moreover, when low-priced imports are intermediate goods, the gains extend to domestic industries using those goods, thus permitting, at the macro level, positive job creation.  Implementing restrictive policies (e.g., tariffs, quotas, duties, etc.) designed to “protect” jobs from being lost to trade (the visible problem) thus suppresses a nation’s wealth potential.

What’s more, this focus on the visible misdirects attention away from doing what is necessary to ensure that the wealth-enhancing gains from trade are fully realized and that trade-related structural change does not produce lasting localized hardships.  In other words, instead of forgoing resource savings and the gains to consumers (including industrial consumers) from low-priced imports in order to “protect” jobs, would it not be better to have a rapidly expanding domestic economy characterized by continuous new job creation?  It is no coincidence, I believe, that Mr. Trump’s pronouncements about the “costs” of trade come at a time when the U.S. has experienced an historically tepid recovery following a severe recession.  Had economic growth been anywhere close to historical norms since the 2008 crisis, it is doubtful that complaints about other nations “stealing” U.S. jobs would have nearly as much currency.

So, the real question to be asked is how do we restore economic growth. This is the problem to which Mr. Trump and others should direct their attention.  Undesired resource idleness does not occur in a vibrant economy with expanding job opportunities.  The goal should be to accrue all of the gains from low-cost imports while maintaining full employment at home.

Putting the economy back on a job-creating growth path will, in turn, require addressing the several significant self-imposed interconnected impediments to that path.  These include, among others, the massive and growing overlay of federal regulations on business; leviathan government spending that saps the economy of productive resources; and a tax system that hinders capital accumulation and is laden with special interest provisions that distort allocative efficiency.

Space here does not permit a full discussion of these yokes on growth and job creation, but a few facts illustrate the magnitude of the yokes.

Regulatory Costs:

According to estimates made by the Competitive Enterprise Institute (CEI), federal regulations imposed a $1.88 trillion cost on the U.S. economy in 2014.  Those costs include direct and indirect costs on businesses and higher prices on goods and services to consumers.  CEI estimates that, all told, the costs amount to nearly $15,000 per U.S. household.  This number would of course be even higher if state and municipal regulations are added in.

Of course, not all regulations are bad. Nonetheless, a $1.88 trillion burden on the economy certainly contains substantial overreach.   In turn, each dollar of unnecessary cost on businesses reduces the output rate at which a business maximizes its profit and thus reduces its demand for labor.  Moreover, the enormous compliance burden diverts resources away from more productive uses that would otherwise expand the size of the economy, and the higher prices on final goods mean that consumers’ real income is reduced.  The end result is stunted growth and fewer jobs.

Spending and Taxes:

Federal government spending for fiscal year 2015 was $3.7 trillion.  Total government spending (including state and local government) was $6.4 trillion. At the same time, the federal government took in $3.25 trillion in tax revenue.  State and local governments took in another estimated $3.1 trillion.  Such a huge diversion of resources away from private, productive uses robs the nation of both wealth and jobs.

In addition, the inefficiencies that spending and taxing policies impose on the economy hinder growth and job creation still more.  For example, special interest tax provisions and spending programs vitiate market-determined resource allocation.   The result is distortions throughout the economy.  Further, taxes on business income, capital gains, and income from savings reduce the returns on capital and make capital less desirable to accumulate.  Less capital accumulation means slower economic expansion and less demand for labor.

Summing Up:

Low-priced imports that American buyers find cost-effective and that provide the opportunity for expanding the total national wealth are a net benefit to the U.S., not a cost.  Restrictive trade policies that focus only on the visible hardships suffered by those most affected by trade misperceive the real problem, a near stagnant economy characterized by slow growth.  In the end, such polices will not only fail to stop inexorable structural change, but make the country poorer.  Far better would be to restore a vibrant, robustly growing economy in which there is continuous job creation that ensures an abundance of new opportunities for those otherwise displaced by expanded trade.  Of course, where short-term transition assistance is needed, that assistance should be provided, but long term unemployment need not be the norm. The next president will have a fresh opportunity to refocus on growth.  A good start toward this end is serious reduction in regulatory overreach, overhauling the tax system to remove anti-growth biases, and major cuts in the amount of national income that big government consumes. — The Chinese and the Mexicans are not the problem.  The problem is us.

Paying One’s “Fair Share” of Taxes Redux

Theodore A. Gebhard

[Note:  This post is an update of an earlier one to take account of more recent developments, including President Obama’s news conference on May 6, 2016.]

In his news conference on Friday (May 6), President Obama reiterated his claim that, owing to tax loopholes, the wealthy do not pay their “fair share” of taxes, a claim he has made several times during his presidency.  Vermont Senator Bernie Sanders has made this same claim in most, if not all, of his presidential campaign speeches.  Former Secretary of State Hillary Clinton has also stated that, if elected president, she intends to institute a four percent “Fair Share Surcharge” on Americans who make more than $5 million a year.

I have always been puzzled when I hear politicians, particularly Democrats and others of the left, talking about people needing to pay their “fair share” of taxes.  What President Obama, Senator Sanders, and Mrs. Clinton mean by this idea is that those earning higher incomes owe society more in taxes than they already pay, notwithstanding that income tax rates are already progressive, i.e., marginal rates increase with income.  Rarely, however, do proponents of raising rates on high income earners say exactly what a “fair share” of taxes is or, more precisely, what the upper limit, if any, of a “fair share” of taxes is.  Even more vague is their philosophical basis, either in ethics or some other grounding, for what constitutes “fairness” in this context.

It seems to me that Obama, Sanders, Clinton, and others of similar views have the tables turned upside down.  In fact, rather good philosophical arguments can be made from both an ethics and an economics perspective that, if anything, high income earners are already paying well more than their fair share of taxes and that their absolute tax payments or marginal rates should therefore be reduced.

Taxes are the cost of financing government.  In our democracy, every qualified voter is afforded one vote, no more and no less.  Just as this political shareholding is allocated equally among citizens, it would seem intuitively fair that the burden of the cost of government should similarly be allocated equally.  That is, everyone should pay the same amount in taxes in the form of a simple per capita tax.  This way, each person contributes the same amount toward the cost of government, much like dues assessments in a club.  At the least, it would be interesting to ask President Obama, Senator Sanders, and Mrs. Clinton to explain, from an ethics standpoint, why their proposals to make taxes even more progressive, i.e., even more unequal, are fairer than an equal per capita tax.

Of course, as a practical matter, given the current size of government, an equal per capita tax would necessarily mean that many, if not most, taxpayers would owe more than they earn or have in savings and, in some cases, likely much more.  Such a tax thus would be unworkable unless government were shrunk substantially.  The cost of government would have to shrink at least to the point where the per capita tax would be affordable by each taxpayer, a goal unlikely to be shared by the political class, left or right.  Even so, the size of government and the practical ability to have fairness in the tax code would seem to be inextricably linked.

Admittedly, I am uneasy to render judgments on purely ethical grounds about whether the amount of taxes a particular taxpayer pays is fair for that taxpayer.  I do, however, claim some expertise in economic reasoning.  On that basis, I think an argument can be made that, in the alternative to a per capita tax, a regressive income tax is actually fairer than a progressive one.

The argument rests on the idea that whenever there is voluntary exchange, every transaction creates wealth.  A voluntary transaction will not take place unless each party becomes better off as a result of the transaction.  It follows therefore that, so long as high income earners obtain their income through voluntary exchange of their labor, services, or other resources, each dollar of that income is the product of a wealth-creating transaction.

Significantly, however, the high income earner does not keep all of the created wealth, but only a fraction.  The rest of the new wealth necessarily accrues to everyone else with whom the high income earner engaged in voluntary exchange, either directly or indirectly.  Thus, the higher the income of the high income earner, the greater the earner contributes to other people’s wealth.  It follows then that high income earners benefit society more than lower income earners before any taxes are taken out of those earnings.

Based on this reasoning, one possible way to measure tax fairness would be on the basis of relative additions to aggregate social wealth.  Under such a definition, people who contribute less to social wealth would be required to make up for the deficit by paying more in taxes, while those who contribute most to social wealth would be rewarded by lower taxes.  Put another way, fairness would require that high income earners be taxed less than low income earners.  The former have already made a disproportionate positive contribution to social welfare.

Of course, as with the per capita tax, a regressive income tax would require considerable downsizing of government.  Such a tax simply could not finance the current government.  Once again, the size of government and the practical ability to have tax fairness are inextricably linked.  But that practical consideration aside, a fairness argument for a regressive income tax that rests on economic reasoning, unlike the Obama, Sanders, and Clinton fairness arguments, at least has an analytical grounding.  It would be interesting to learn how they would respond to the argument.

In that regard, I will myself volunteer one necessary exception to the general conclusion.  The exception owes to the fact that many high income earners today derive their high incomes not from contributing to aggregate wealth but rather by using the machinery of government to expropriate the wealth created by others.  Rent seeking can be very lucrative.  Thus, if “paying one’s fair share” in taxes is inversely related to one’s contribution to social wealth, these high income rent seekers should be taxed at a 100% marginal rate.  Given that the Democratic left has its own set of favored rent seekers, however, I am not sure that Obama, Sanders, and Clinton could even agree to this exception.

To be sure, I write all of the above with a considerable amount of tongue in cheek.  I stand by the larger point, however, that tax “fairness” is hardly a known parameter, and that one can construct ethical and/or syllogistic arguments leading to completely opposite conclusions as to what is fair.  In view of this conundrum, it seems to me that we all would be better served if politicians and policy makers purged “fairness” from their thinking (and speeches) and simply focused on a tax system that finances essential government functions in the most efficient manner possible and impedes economic vitality and long-term growth as little as possible.  I suspect that, in a prosperous and growing economy, questions of “fairness” will lose much of their political cachet and recede to the academic lounges where they belong.