Month: September 2021

China’s Export Subsidies Are a Gift

Theodore A. Gebhard

[Note: This post originally appeared in The Daily Economy at the website of the American Institute for Economic Research on Sept. 16, 2021]

Instead of making a beeline to the nearest Hallmark store to buy thank you cards to send to the Chinese government for the subsidies it provides to Chinese exporters, the Biden Administration is reportedly developing a strategy to add new sanctions against China, including new tariffs on Chinese imports. According to the Wall Street Journal, the Administration furthermore wants to elicit the assistance in this effort of Japan and other Asian nations as well as seek support within the broader World Trade Organization. Such a strategy would carry on, at least in spirit, the Trump Administration’s conflation of the costs and benefits of trade. It is a policy that not only says “no thank you” to what should be a welcome gift but perversely says that because China chooses to shoot itself in the foot, the United States and its allies must retaliate by doing likewise.

Consistent in spirit with this new strategic initiative, the U.S. International Trade Commission currently has fourteen ongoing investigations of “import injury” in which China is implicated. Imported products under investigation include such items as pipe fittings, flat steel, woven ribbon, wax candles, and tissue paper. These investigations seek to determine whether domestic sellers have been “injured” (i.e., have lost sales) owing to Chinese competition at allegedly unduly low prices to which subsidies may contribute. 

The potential new sanctions, as well as the ITC investigations, rest on the idea that China deliberately engages in “unfair” competition that must be challenged or otherwise punished. Specifically, China’s export subsidies (and also as alleged from time to time, its currency manipulation) are said to be trade practices deliberately designed to enrich its economy at the expense of the United States and other trading nations. Among other harms, it is alleged that these trade practices unfairly cost American jobs and injure American businesses, all to the detriment of the American economy. 

This conclusion, however, is firmly rooted in mercantilist thinking long rejected by sound economics. In particular, it miscomprehends costs and benefits.

Distinguishing Costs and Benefits

In An Inquiry into the Nature and Causes of the Wealth of Nations, Adam Smith, the 18th century Scotsman considered by many to be the founding father of modern economics, expounded his seminal insight, novel at the time, that a nation’s economic well-being – its true wealth – is measured not by its store of gold or currency, the amount of goods it exports, or the number of jobs that exist within its borders, but rather by the quantity of consumption goods and services available to satisfy human wants and desires. Smith makes the point that economic activity takes place so that people can consume. In other words, the ultimate purpose of economic activity is the satisfaction of wants and desires through consumption. Work and production are means to that end, but not ends in themselves. In a world in which resources are scarce, employment of labor and other factors of production are the costs that a nation incurs in order to consume.

Consumption goods and services, however, must first be produced or otherwise acquired from someone else who has produced them; for example through trade. Because consumption takes place over time, resources must therefore be constantly employed to yield goods and services that satisfy ongoing wants and desires.

In the context of trade, exports thus represent a cost to a nation and imports a benefit. Exports require the employment of a nation’s scarce resources for another nation’s consumption benefit. By contrast, imports are a benefit. Importing goods and services allows a nation to consume while conserving its own scarce resources. These resources are then available for deployment in other productive activities, thus expanding domestic output and permitting even greater rates of consumption. That is, the freed up resources expand the nation’s production possibilities. The result is an increase in the nation’s total wealth. Rightly considered then, exports, and the resources that go into those exports, are the price a nation must pay for its imports. 

Notwithstanding this price, however, trade permits a nation to conserve scarce resources on net. This occurs whenever goods and services are able to be acquired more cheaply through trade than the resource cost attendant to domestic production. In this regard, a nation is no different from an individual. To the individual, the lower the price, the greater the surplus value; and the money that is conserved is available to be spent on other items that enrich life even more. In the aggregate, whenever U.S. buyers can obtain goods and services more cheaply by means of importing them than by buying them domestically, consumers in the present are made better off and resources are conserved, permitting expansion of future consumption. The nation’s wealth potential is enhanced.

Significantly, these benefits will accrue regardless of whether the imported goods are cheap, i.e., even if they are cheap because of subsidies or an undervalued currency. Indeed, if subsidies or artificially undervalued currency is the reason (as opposed to, say, Ricardian comparative advantage), the true harm falls on the citizens of the nation providing the subsidies or “manipulating” its currencies. Not only is that nation using up its scarce resources for the benefit of foreign consumers, but its citizens are being taxed to fund the subsidies and are being exposed to higher domestic prices of imported goods because of the undervalued currency. It is a double whammy.

In light of the above, if the Biden Administration carries out its threats to impose sanctions on China, it would add harm on top of harm. Tariffs, for example, would harm U.S. buyers by eliminating the option provided by the cheaper Chinese goods. To the extent that some of these subsidized goods are intermediate goods such as raw materials and other inputs, the resulting higher costs can be expected to generate higher prices over a wide range of output. In the aggregate, U.S. wealth will be less than it otherwise could be as conserved resources that would expand production possibilities are forgone. 

To be sure, export subsidies can result in certain industry-specific disruptions and transactional costs to individuals working in those industries. This inevitable consequence is by all means a basis for a compassionate nation to lend support to those who require retraining and other transitional assistance, but it is not a basis for protectionism and lower living standards on the whole. Instead of forgoing resource savings and the gains to consumers (including industrial consumers) from low-priced imports, would it not be better for the Administration to focus on policies that restore the rapidly expanding domestic economy that preceded the pandemic? 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 post-pandemic growth path will of course include efforts to lubricate global trade that benefits the U.S. Attacking Chinese export subsidies should not be part of that effort, however. Time would be better spent focusing on domestic impediments to restoring growth such as excessive federal regulations on business, leviathan government spending that saps the economy of productive resources, and a tax system that hinders capital accumulation and distorts allocative efficiency. Sadly, the current Administration is moving in the wrong direction on each of these issues, subject matter for further comment in subsequent posts.

Summing Up

Economists do not always agree on everything, but there is little or no disagreement across all schools of economic thought on the foundational principle that the ultimate purpose of all economic activity is to satisfy human wants and desires. In other words, the ultimate purpose of economic activity is consumption.

Chinese export subsidies are a boon for U.S. consumers, permitting them to satisfy wants and desires for less. Moreover, the savings can be redirected to other productive activities, thus expanding U.S. wealth. Misguided retaliation that would eliminate the advantages that cheaper Chinese goods offer would result in unnecessary self-inflicted costs and forgone benefits to the American economy. Better simply to give a hearty thanks for the gift.

What is Tax Fairness?

Theodore A. Gebhard

[Note: This post originally appeared in The Daily Economy at the website of the American Institute for Economic Research on Sept. 7, 2021]

Politicians, particularly those on the left, routinely proclaim that businesses and high income individuals should pay their “fair share” of taxes. This necessarily assumes that there is not only a share of taxes that is fair but also that a fair share can be determined. Such assumptions, however, are never made explicit, nor do proponents of higher taxes on these groups explain their method for determining fairness. Rather, we hear only vague notions of “fairness” based on seemingly highly subjective beliefs. This begs the question of whether tax fairness should even enter any discussion of tax policy. I hold that it should not.

The question is timely because House and Senate Democrats, as part of their budget reconciliation bill, are presently seeking to raise taxes on both corporations and high income earners, claiming that these groups do not now pay their “fair share” of taxes, Senator Elizabeth Warren (D-MA.) introduced a bill earlier this month in which she states that higher taxes on corporations are necessary to ensure that they “pay their fair share so that we can raise essential revenue needed to invest in families and our economy.” This bill, intended to be part of the larger Democratic reconciliation bill, has been introduced in the House in substantially the same form by Rep. Don Beyer (D-VA). Meanwhile, Senate Budget Committee Chairman, Bernie Sanders (I-VT), aims at increasing taxes on high income and high wealth individuals. He tweets, “We’re going to tax the wealth of these billionaires, and with the Budget Reconciliation Legislation, we are finally going to invest in the needs of the working class of this country. Trust me, I wrote the damn bill.” President Biden too believes companies and high income earners do not pay enough taxes. In a speech last May, he asked, “Is it more important to shield millionaires from paying their fair share [of taxes], or is it more important that every child gets a real opportunity to succeed from an early age and ease the burden on working families?”

Significantly, all that we can glean from these pronouncements is that Biden, Sanders, and Warren believe that businesses and those earning higher incomes owe society more in taxes than they already pay, notwithstanding that income tax rates on individuals are already progressive, i.e., marginal rates increase with income. Never stated is a reasoned basis, either in ethics or some other grounding, for this belief or if there is an upper limit to what businesses and higher income earners owe to society.

Setting corporate taxes aside to focus on individuals, I suggest that reasoned arguments can be made from both an intuitive 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. My point is not to advocate for such a policy; rather it is only to suggest that the concept of “fairness” is so porous and subjective that it is possible to arrive at completely contradictory conclusions about the meaning of tax fairness. Hence, it is nonsensical to base tax policy on such conclusions.

For example, a fixed per capita tax is arguably fairer than a progressive tax. 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 thus 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, one might ask Biden, Sanders, and Warren 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.

Admittedly, purely intuitive judgments on the ethics of tax policy – let alone the ethics of a per capita tax – do not rest on the solidest of foundations; so let me offer an alternative argument for defining fairness based on economic reasoning. 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, tax fairness might be gauged on the basis of relative additions to aggregate social wealth. Defining tax fairness in this fashion would then mean that tax policy require people who contribute less to social wealth to make up for the deficit by paying more in taxes, while those who contribute most to social wealth be rewarded with 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. Once again, one might ask Biden, Sanders, and Warren how their positions are analytically any sounder.

Of course, as a practical matter, given the current size of government, either an equal per capita tax or a regressive income 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 required taxes would be affordable by each taxpayer, a goal unlikely to be shared by the political class, left or right. 

Another practical flaw concerns rent-seeking, whereby some high income earners today derive their high incomes not from contributing to aggregate wealth but by using the machinery of government to expropriate the wealth created by others. 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 or near a 100% marginal rate. Given that the left has its own set of favored rent seekers, however, it is unlikely that agreement could even be reached on this exception.

To be sure, I write all of the above not to advocate for either a per capita tax or a regressive income tax — political non-starters in any event – but to show that “tax fairness” is hardly a known parameter. One can construct ethical and/or syllogistic arguments leading to completely opposite conclusions. In view of this conundrum, 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.