The Republican tax plan that passed at the
end of 2017 was a rare legislative victory
for President Trump.
But it is likely it will undermine Trump's
other major promise, which is to cut the US
trade deficit.
The GOP's tax law is virtually certain to
widen the budget deficit and increase the
current-account deficit, which is what happened
following Ronald Reagan's tax cuts of 1981-1983,
and George W. Bush's tax cuts of 2001 and 2003.
Four different ways of thinking about the
problem, all give the same basic answer: trade
deficits will worsen.
Number one: a simple model predicts that a
tax cut boosts income and spending.
The recipients of that spending will spend
some of the additional income on foreign goods,
boosting imports and worsening the trade balance.
Number two: what about when the economy is
at full capacity, as the United States is
now?
The increased spending goes entirely into
the current-account in that case.
The reason is when output is constrained,
the increased demand tends to lead to inflation.
Higher prices for US products will reinforce
domestic consumers' incentive to buy foreign
goods, while reducing external demand for US exports.
The result, again, will be a larger trade deficit.
Number three: Trump also promised that a burst
of investment and productivity will rise in
the future, following the tax bill; this,
too, will lead to a widening of the trade deficit.
Number four: The White House is counting on
the lower corporate tax rate to attract foreign
investment.
This capital inflow will be even larger if
the US Federal Reserve continues to respond
to increases in demand by raising interest rates.
That will drive up the value of the US dollar,
undermining the international price competitiveness
of US exports, and capital inflow will worsen
the trade balance further.
So, four approaches, same answer:
the deficits will worsen.
That's the actual deficits.
It is possible that the reported trade deficit
will narrow even as the true trade deficit
widens.
The reason is tax-motivated profit-shifting
by US multinational corporations that has
long made America's trade balance appear
worse than it really is, will now diminish.
But there is a difference between the reported
balance and reality.
In short, any narrowing of the trade deficit
would be illusory, and the current-account
balance will worsen, both in reality and as reported.
No matter how you look at it - whatever model
you use - the Republican tax cut will widen
the US budget deficit and the current-account deficit.
It's the twin deficits, which we had in
the early 1980s all over again.
But it's not morning in America.
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