Monday, July 22, 2024
Home Economic Trends Trade wars are easy to win, and income taxes are easy to abolish.

Trade wars are easy to win, and income taxes are easy to abolish.

by xyonent
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It goes without saying that a significant portion of politicians and citizens believe that international trade is harmful to the U.S. economy and therefore that enacting high tariffs and other trade barriers would benefit the U.S. economy. This debate has been going on for centuries, and I have no illusions that it can be resolved here. However, I can provide some facts relevant to two of the most outlandish claims.

For example, in 2018,President Donald Trump tweeted“When a country (the United States) is losing billions of dollars in trade with almost every country we trade with, trade wars are good and easy to win. For example, if we lose $100 billion in trade with a country and they get soft, we just stop trading and we win big. Easy!”

President Trump has used executive orders to raise tariffs and enact trade barriers, and President Biden is largely following suit when it comes to trade policy. So was this trade war actually easy to win? The chart above shows the pattern of U.S. imports (blue line) and exports (red line) as a percentage of GDP since 1980. The chart below shows “net exports,” the difference between the two lines, which can be used as a measure of the U.S. trade deficit.

If you’re even a little curious, you might be thinking: “Since about 2018, tariffs have been raised substantially, especially against China, but also against other parts of the world. But the trade balance has not changed. In fact, it’s a little worse than it was before. Why is it so hard to win a trade war? (One might wonder).”

The obvious answer is that trade has many paths through the global economy: restricting direct trade with China would make it more likely that China would export to a third country (such as Vietnam) and then from there to the US.

But the less obvious but more fundamental answer, taught in almost every introductory economics class, is that a country’s trade balance has nothing to do with whether other countries are trading “fairly.” If you look at the trade deficit graph above, there is no evidence that movements up and down in the trade deficit follow the pattern of other countries’ trade “fairness.” When trade deficits fell in the late 1980s or from 2005 to 2010, we didn’t see any big headlines about “global fairness in trade is improving.” That’s because trade balances are about large macroeconomic factors.

When the trade balance is zero, the value of foreign currency earned by U.S. exporters is equal to the value of U.S. dollars earned by sellers of imports to the U.S. economy. For a country with a trade deficit, like the United States, the value of foreign currency earned by U.S. exporters is less than The value of the US dollars earned by sellers of imports to the US economy. In the case of a trade surplus country like China, the value of foreign currency earned by Chinese exporters (including the US dollars they earn) is Greater than The amount paid by the Chinese importer in Renminbi.

How can such an imbalance exist? In other words, countries around the world earn US dollars as the US economy imports goods and services from countries like China. We know that these countries don’t use all of their US dollars to buy US exports. If they did, the US would not have a trade deficit. So what are these countries doing with their US dollars? The answer is that they are investing them in financial assets, including US Treasury bonds.

of The U.S. Bureau of Economic Analysis tracks total U.S. holdings of foreign assets and total foreign holdings of U.S. assets. The trade deficit has steadily reduced the difference between the two — the U.S. economy’s “net international investment balance” (see chart).

Could the “net” line between U.S. liabilities to foreign investors and U.S. investors’ assets to foreign liabilities continue to fall? This is somewhat debated, but the answer appears to be “yes.” The reason is that foreign investors in the U.S. economy tend to buy bonds with lower interest rates, on average, while U.S. investors in foreign economies tend to buy ownership interests in companies with higher interest rates, on average. As a result, U.S. investors holding foreign assets end up earning more as a group than foreign investors holding U.S. assets (see this 2021 post for more on these debates).

Some readers may worry that what I just wrote is vague and not clear enough. It would be easier to explain it in the sixth lecture of an introductory macroeconomics course where you have had a chance to get the basics down. But the bottom line is that trade deficits are a result of macroeconomics and are based on whether a country’s consumption exceeds its production and the types of financial investments that are being made in different economies around the world. Roughly speaking, the United States has a trade deficit because it runs its macroeconomy in a way that consumption exceeds production (e.g., large budget deficits). China, on the other hand, has a trade surplus because production exceeds consumption (e.g., by forcing households to have very high savings rates).

But leaving aside the question of whether it’s easier to “win” a trade war with tariffs (as opposed to simply starting one), it turns out that Trump was, as reporters put it, “hiding a lead” in 2018. According to Trump, increasing tariffs would also allow the US to eliminate income tax. Perhaps the potential benefits of this tariff were mentioned back in 2018. But the math and economics of this proposal are confusing.

The basic calculation is U.S. personal income will be about $23 trillion in 2023.. U.S. income tax collections reach $2.2 trillionThis represents roughly half of the U.S. federal government’s revenue, with the other half coming from payroll and corporate income taxes, primarily supporting Social Security and Medicare, along with smaller sources such as federal excise taxes on gasoline, alcohol, and tobacco, and estate taxes. Imports of goods and services in 2023 (figures in graph above) were $3.8 trillion.

Simple math shows that a tax of about 60% on $3.8 trillion would raise $2.2 trillion. But of course a 60% tariff would reduce imports so much that a higher tax would be needed on the remaining imports to raise the $2.2 trillion. So this idea of ​​using tariffs to offset U.S. income taxes would surely require a tariff rate close to 100% or even higher.

Proponents of tariffs seem to think that tariffs are a way to tax foreign companies without affecting American households, but of course they’re wrong. Tariffs are essentially a type of excise tax — a consumption tax on imported goods. It’s possible to substitute a national sales tax (or value-added tax) revenue for U.S. income tax, but few middle- or low-income households would consider that a win, because they know that a higher sales tax means higher prices at the register. Similarly, if we put a 100% tariff on, say, all imported oil, gasoline prices would rise at the same time.

Moreover, other countries would use the increased U.S. export tariffs to impose countervailing duties on U.S. exports. In this scenario, U.S. industrial companies and workers who are heavily dependent on $3 trillion in U.S. exports in 2023 (everything from agriculture to pharmaceuticals) would see their global sales plummet. The disruption to the U.S. economy from this retaliatory tariff scenario would be dramatic at best and recessionary at worst.

Again, I can’t hope to make a broad argument for the merits of international trade in a short post, but if there remains any serious doubt that tariffs are an effective means of reducing trade deficits and can be a painless way to eliminate U.S. income taxes, then my work here is done.

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