Scoring the Trump Trade Plan: Magical Thinking

Who knew Donald Trump was a fan of Latin American fiction?
September 28, 2016 12:00 PM

Back in the 1970s, Gabriel Garcia Marquez, Isabelle Allende, and other Latin American writers developed a literary style featuring wild juxtapositions and metaphysical leaps that came to be known as magical realism. “Scoring the Trump Economic Plan: Trade, Regulatory, and Energy Policy Impacts,” by Peter Navarro and Wilbur Ross owes much to the genre.

It is a political document. The challenge for the authors is that the impartial arbiters concluded that the tax plan of Republican presidential candidate Donald Trump will cost the US government $2.6 trillion in revenue over 10 years. Mr. Trump wants his tax proposal to be “revenue neutral” so his advisors need to fill that hole.

By their own reckoning they come close, finding $2.374 trillion in additional revenue. They do this by imputing positive growth effects to various trade, regulatory, and energy reforms and then calculating the tax raised on these increments to GDP. The imputed trade policy component of additional revenue is $1.74 trillion or almost three-quarters of the projected total. So trade policy is central to the Trump story.

Unfortunately, the thinking that gets them the $1.74 trillion figure is truly magical. The authors observe that between 1947 and 2001 (the good old days, when America was great), the economy grew at 3.5 percent annually. Since then it has grown at an average of 1.9 percent. They allude to the idea that demographics—lower labor for growth and a rising dependency ratio—might have something to do with it, only to dismiss this explanation. They entirely ignore the ongoing debate about the sources of productivity growth and the possibility that the rate of technological change is slowing. Instead, they focus on trade. Or more specifically, “disastrous” trade agreements.

And how do they get that $1.74 trillion in revenue? They observe that the United States has a $500 billion deficit in merchandise goods and services…and then they make it disappear! (Luis Borges would be proud.) But don’t believe me, here it is in their own words (emphasis added):

“To score the benefits of eliminating trade deficit drag, we don’t need any complex computer model. We simply add up most (if not all) of the tax revenues and capital expenditures that would be gained if the trade deficit were eliminated. We have modeled only the impacts of implicit profits and wages, not any other economic aspect of the increased activity.

Trump proposes eliminating America’s $500 billion trade deficit through a combination of increased exports and reduced imports. Again assuming labor is 44 percent of GDP, eliminating the deficit would result in $220 billion of additional wages. This additional wage income would be taxed at an effective rate of 28 percent (including trust taxes), yielding additional tax revenues of $61.6 billion.

In addition, businesses would earn at least a 15% profit margin on the $500 billion of incremental revenues, and this translates into pretax profits of $75 billion. Applying Trump’s 15% corporate tax rate, this results in an additional $11.25 billion of taxes.

This leaves businesses with $63.75 billion of additional net profit which must be distributed between dividends and retained earnings. If businesses pay out one third of this additional profit as dividends and these $21.25 billion worth of dividends are taxed at a rate of 18%, this yields another $3.8 billion of taxes, after which there remains $17.45 billion of net income.

Together, these tax revenues from wage, corporate, and dividend income total $76.68 billion per year and over the standard ten-year budget window, this recurring contribution to the economy cumulates to $766.8 billion dollars of additional tax revenue.

To this total, we must add at least two more increments of revenues. Under the dividend payout schedule, we have noted that businesses will retain $42.5 billion of cash flow after paying both taxes and dividends.

Reinvesting this $42.5 billion each year at even as subpar a return as 5 percent pretax per year on the cumulating balances invested and assuming reinvestment of the post tax proceeds each year at the same 5 percent pretax return generates another $120.21 billion of pretax profits and taxes of $18.04 billion over the standard 10-year budget window. Adding these increments to the previous calculation results in a ten-year direct incremental contribution to Federal tax revenues of $766.8 billion in 2016 dollars.

Since taxes are paid in nominal, not real, dollars, we have applied to them a 1.1082 inflation factor for a total of $869.76 billion of incremental tax revenues over the ten years from the elimination of the trade deficit.

This is an intermediate calculation. To account for multiplier effects, we must add our conservative multiplier of 1.0 (versus the National Association of Manufacturers’ 1.81 multiplier). This produces a grand total from trade of $1.74 trillion of additional Federal tax revenues.”

Maybe it reads better in Spanish.

Economists generally believe that the magnitude of a nation’s trade deficit fundamentally reflects the difference between saving and investment—if you are consuming more than you produce, you run a deficit, if you produce more than you consume you run a surplus. Trade policy can affect the sectoral and geographic composition of the deficit, but in the long run, the trade balance is determined by the saving-investment balance. If you want to lower the nation’s trade deficit, increasing the saving rate, not launching a trade war would be the right place to start. But there is not a word of this in “Scoring the Trump Economic Plan: Trade, Regulatory, and Energy Policy Impacts.” It’s all perfidious foreigners and incompetent trade negotiators instead. Maybe that makes for a better plot. But it does not constitute a persuasive defense of a questionable tax plan or a solution to the trade deficit. Quite the opposite—it’s another instance of the type of magical thinking best reserved for fictional realities.

Comments

Steve Wallis, Ph.D.

We've done an analysis of the Trump Economic Plan from a "structural" perspective - and came up with much the same conclusion. Not only is the plan not viable, it is likely to be dangerous to our environment as well as our economy. White paper here (or by email request): https://www.researchgate.net/publication/308929819_Scoring_the_Score_A_Structural_Evaluation_of_Trump's_Economic_Policy

Daniel Brockman

Donald promises massive increases in DOD spending and infrastructure spending, and reduced income taxes on a lightly taxed aristocracy (https://www.donaldjtrump.com/). More spending, less revenue. It is fantasy.

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