FOOL ME THREE TIMES, YOU MUST BE KIDDING?
Anthony C. Bernardo
In a recent article for Bad Subjects, “Things Both Crazy and Stupid: The Laffer Curve”, I demonstrated how the application of supply side economics based on economist Arthur Laffer’s tax revenue curve has resulted in massive deficit build up over twenty years of application, under Presidents Reagan, George H. W. Bush, and George W. Bush.
In this article, I’m going to try to explain what will happen if this tax policy is resurrected by Donald Trump. What will happen with deficits and debt, the ability of the Federal Government to meet financial obligations, the effect on jobs, the dollar index, on inflation, and that the expected result will be a recession.
As a fast review, Arthur Laffer reputedly proposed a tax plan to Mr. Dick Cheney in 1976, later to be Vice President Cheney in 2000, in support of conservative thinking that reduced tax rates benefit the economy. He proposed a bell curve where at both 0% and 100% tax rates, the revenue collected by the Federal government would be zero. Somewhere in between 0% and 100% tax rate was a peak where increasing rates to the left of the peak would result in increasing total tax revenue while increasing rates to the right of the peak would result in decreasing total tax revenue.
The latter point implies that reducing tax rates on the right side of the peak will result in tax revenue increases.
While there are many problems with this theory, the main one is that no one, not even Mr. Laffer, knows the value of X%, that tax rate which maximizes tax revenue for the federal government. Yet, the Republican Party is consistently proposing that reducing tax rates will give us increased investment, more business activity, more jobs and consequently higher tax revenue to support our ever-growing obligations to Social Security, Medicare/Medicaid, interest on the increasing debt, defense of the United States, and the rest of the Federal Budget (1).
For those that really want a look at the actual numbers, please go to USfederalbudget.us and you’ll be able to see where our tax dollars are spent. There is no basis for that promise unless we know where the peak of the curve exists; anything currently is just a guess.
The real problem is that the Republican Presidential candidate, Mr. Donald Trump, is proposing the same old tax cuts that have dominated Republican economic thinking for four decades or more- unsuccessfully- and one of Mr. Trump’s economic advisors is none other than Mr. Laffer.
Three administrations, twenty years of applying Mr. Laffer’s theory, all resulting in massive deficits, and we have a fourth candidate ready to do the same. As the saying goes, you can’t make this stuff up. President George H. W. Bush called it “voodoo economics”, no offense to the practice of voodoo intended, and went on to prove it in both his and Mr. Reagan’s administration, but here we are again at deficit doorstep if Mr. Trump is elected.
But wait a minute, or two. If Mr. Trump is elected, and if he can successfully call for a tax rate decrease through the House, what will happen? Will we pay less in taxes?
Well yes, many of us will. Will we be able to finance our major Federal Government obligations of Social Security, Medicare/Medicaid, Defense, and Interest on the debt? Not likely. The Tax Foundation (2)) has recently indicated a $4.4 TRILLION DOLLAR increase to the debt over 10 years. Originally, it estimated an increase of $ 10 Trillion.
Will we have a repeat of the massive deficits we ran the last time this tax policy was implemented, under President George W. Bush? It’s very likely, and actually more likely because of other policies of Mr. Trump. For example, he wants to penalize corporations that outsource work to Mexico or other locations and return those jobs back to the United States. That may generate tax revenue, but what are the costs?
Will we pay less in taxes? Some of us will, especially Corporations and the top percentage earners. That’s where the Trump tax plan (3) will have the most impact. By reducing the corporate tax rate from around 35% to 15% he is reducing tax revenue. Corporations pay surprisingly low taxes, about $350 billion a year right now. Total government revenue from all taxes (income tax, payroll tax, excise tax, corporate taxes) was about $3.2 trillion in 2015. Corporations, consequently pay about 11% of the tax revenue collected by the Federal government (3).
Because of loopholes and deductions, most major corporations don’t pay the 35% tax rate. Smaller companies may pay that rate, and the proposed 15% rate will be a real benefit to them. The actual average corporate tax rate after deductions, loopholes etc. is really between 20-25% currently. As is well publicized, some major corporations, like GE, have had zero tax obligations in prior years. It’s all perfectly legal. If we use the actual effective rate of 20-25% as the base, reducing the corporate rate to 15% will reduce tax revenue by around $90 billion. Corporations will then pay about $250 billion, or 8% of the total taxes paid in the US based on 2015 figures.
Also, the new tax rate proposed by Mr. Trump will be exorcised of all loop holes, but we’ll see how that turns out. We could actually see less than anticipated revenue if those loopholes aren’t eliminated.
Will we pay less in taxes?
Yes. The Trump plan reduces the tax brackets to only three, and the biggest effect is on those families with incomes between 0-$50,000 per year where the tax rate will become 0%.
Keep in mind, that’s close to 50% of the working population. Families earning above $300,000 will see a nice decrease to 25% from the current approximate 35%-40%. Families earning between $100,000-300,000 will see a tax rate of 20%, which could be a decrease, or an increase depending on circumstances. Many in this group will see their taxes increase. So the answer is, yes we will pay less in taxes. But the Tax Foundation estimates that this tax plan will create an additional four trillion dollars of debt.
So we’ll pay less in taxes, but what will we give up to balance the budget? Nothing according to Mr. Trump, as he plans no revision to Social Security or Medicare/Medicaid, and wants to increase the already bloated defense budget of around $850 billion. Those three items represented about $3 trillion out of the total budget of around $4 trillion, or 75%. It’s no shock that the Tax Foundation estimates an additional four Trillion dollars in debt.
Now, will be able to continue to finance those very essential programs of Social Security, Medicare/Medicaid, defense, and pay interest on the debt. No, not without adding debt.
The current Social Security spending by government is around $1 trillion in 2016 and increasing (1). In addition, Medicare/Medicaid spending is approximately $1.1 trillion. Approximately 11,000 people a day are turning 65 years old. It’s estimated that approximately 4 million people a year are retiring. Those retirees, one of which is me, do not contribute to Social Security, they draw from it.
Now a friend of mine asked me, “but how many pass away” per year, so I looked it up; about 2 million. So net, an additional 2 million people per year add to the population of 65+ years old. That adds about $30 – $40 billion per year of Social Security obligation if the average payment is between $15,000 - $20,000 per person (in 2016 it’s $16,000+) (4).
It’s much harder to get at the average benefit paid per person in Medicare, but as the population ages and Medicare obligations increase through age 65+ retirees, it’s a fair bet that these costs will also increase. Don’t forget, the US government already spends $1.1 trillion per year on Medicare/Medicaid obligations. Now this is mitigated somewhat through monthly Medicare fees for those over 65, which are collected through the Social Security system and other programs, but even with this, it is estimated that Medicare Part A will be broke within 12-13 years (4) unless contributions are increased, or the system is changed (meaning less benefits).
So if we decrease taxes per the Trump plan, and don’t do anything to re-vamp Social Security or Medicare/Medicaid, we are going to increase the deficit and the debt. It’s a guarantee.
But that’s not all of it. Mr. Trump wants to increase our defense spending, which is currently around $850 billion in 2016. In addition, spending on Protection is around $40 billion, bringing the total general defense spending to around $900 billion in 2016. Mr. Trump wants to increase this amount. We live in a dangerous world and maybe he’s right. But, it doesn’t help balance the budget.
Again, the Tax Foundation estimates an additional $4 trillion of debt added according to Mr. Trump’s tax plan and the spending obligations of the country. Seen this movie before?
Now let’s look at all the benefits of a tax reduction.
It will create jobs. It will create well-paying jobs? Will it? Isn’t that the whole point of this election, to create jobs and to provide security to the nation?
The good manufacturing jobs Mr. Trump references have not only been lost to outsourcing to lower cost countries, but have also been lost to technology. The jobs lost to technology, by many estimates numbering more than those lost to outsourcing, are not coming back.
I took a tour of the Ford Rouge Plant in Detroit Michigan a few months ago. This is a plant that used to employ around 60,000 people, although at that time its scope was much broader. Today it makes all the Ford F150 series trucks, the largest selling vehicles in the United States at close to 800,000 units in 2015.(5) It employs around 6,000 people(6)). It also employs countless rows of robots assembling the vehicles.
That’s a done deal; those jobs are not coming back.
My suspicion is that any automotive manufacturing facility will exhibit the same structure. In fact, I’ve seen film of Tesla’s manufacturing plant in California without any evidence of a human being involved in the process, although I’m sure they are there. Primarily robotics.
Mr. Trump is making a seriously false promise of bringing back these jobs.
But, I do actually think Mr. Trump’s tax policy may create jobs, and here’s why. By imposing a penalty, be it a tax, a duty, or a cash penalty, on those companies that outsource their manufacturing to Mexico, China, points unknown, it could reverse the trend and keep those jobs in the U.S. Reducing the corporate tax rate could provide additional incentive. This is good, isn’t it?
Companies outsource to other countries for many reasons; I know; I used to do it. Cost reduction is not the major reason.
The major reason is to produce products for consumption close to the market in which they will be consumed, especially growth markets.
For example, while Apple produces I phones in China and imports into the United States, Apple also sell a lot of I phones in China. China has more than three times our population and a growing income base. In fact, in April of 2015 Bloomberg (7) reported that Chinese consumption of I phones was greater than the consumption in the United States. It is highly unlikely that such production will come back to the United States.
It’s the same story for cars and trucks built in Mexico. Mexico has about 100 million population, and while we may hear all about the illegal immigrants (that contribute to our economy through hard work, spending on goods, and virtually support the economies of the Southwestern United States), Mexico is a growth market for vehicles. When Ford, GM, Chrysler, VW, Mercedes, and a boat load of others make their cars and parts in Mexico, it’s to satisfy the Mexican market as well as the United States market.
Yes, cost reduction from labor rates are important in these locations, but sales to the growing markets are a more important reason. From a corporate standpoint, it’s a win-win on both increasing sales and lower costs. It’s not a win for the American worker, for sure, but will it be if these jobs come back?
If Mr. Trumps tax plans and penalty plans are implemented, more high paying jobs will likely be created through delay or elimination of selected outsourcing plans. But what are the consequences?
Higher wages mean higher costs. It means higher inflation. The jobs may come back, or not leave as fast, but it will cost us all in higher inflation. I can’t estimate the balance, but it’s a good bet that what is gained in salaries will be spent in higher cost for goods at some significant ratio.
Higher inflation will also hurt retired seniors and low income workers more than any other groups. Remember that when you’re voting.
So, my take can be summarized, so far because there is more, by a couple of outcomes to Mr. Trump’s tax plan, based on Laffer economics:
-First, tax revenue will decrease even with compensating additions of revenue through potentially higher paying jobs (higher tax revenue) and penalties on corporations that outsource. We have three administrations and 20 years of history on the fallacy that reducing taxes increases tax revenue.
-Second, costs of major obligations will increase due to the aging of the population and the increasing demands on Social Security and Medicare/Medicaid services.
-Third, increase of the defense budget will occur.
-Fourth, while some jobs will no doubt stay in the United States or perhaps come back, the result will be increased inflation and higher cost of goods.
-Finally, as estimated by the Tax Foundation, our deficit will increase and about $4 trillion will be added to the debt over ten years.
The devil is in the details.
What happens when the deficit increases? History will tell us that the dollar index decreases . The dollar index is a comparison of the US dollar with a basket of selected currencies including the Euro, Pound Sterling, the Yen and a number of others (8). The break-even point, so to speak, is 100.
During the Reagan/H.W. Bush Presidency the index went from a high of 164 (strong dollar) to a low of around 80 (weaker dollar). It recovered during the Clinton Presidency (low of around 80 to a high of around 120). It decreased again during the W. Bush Presidency (high of 120 to a low of 75). It has slightly recovered during the Obama Presidency as the deficit has been reduced, but is still below the break-even value of 100.
During the Reagan/H.W. Bush Presidency we increased the deficit significantly. The Clinton Presidency reduced deficits and actually generated surpluses in its last 3 years. The George W. Bush Presidency increased deficits significantly.
The trend is clear; an increase in deficits and the resulting debt/GDP ratio generally coincides with a decrease in the dollar index.
If the dollar index decreases, what else happens?
Imported products become more expensive. We buy a lot of imports. More expensive imports add to inflation. True, we will likely produce more in the US and consume fewer exports, but domestic goods will be at higher costs also due to higher US wages and costs in general.
Consequently, if Mr. Trump’s tax plan is wildly successful, the debt will increase, inflation will increase, exacerbated by both increasing wages for the US worker (I strongly support higher wages for the US worker but through education and higher skill levels, not doing jobs someone else can do at 1/10th the wage) and higher costs for imports due to a lower dollar index.
That inflation will eventually result in a recession, as it has in the past. That is the real scenario of Laffer economics: debt, inflation, recession.
Fool me once; fool me twice, but not three times. “You betcha”, as immortalized by a previous Vice Presidential candidate (9).
(1) U.S. federalbudget.us; usgovernmentspending.com (2) Tax Foundation, Fortune 09/16 (3) Motley Fool, www.fool.com (4) SSA.gov (5) Detroit News (6) Ford Rouge Plant Tour Guide Comments (7) Bloomberg News (8) US Dollar index Macrotrends, Investopedia (9) SNL and countless interviews.
Anthony C. Bernardo Tony has spoken at major industry functions on both technology and business strategy, holds a technology patent, and actively served on a number of industry organizations. He currently consults in business development strategies and also volunteers for community services. He holds a BS in Chemical Engineering and an MS in Management Sciences. Tony is also a jazz guitarist and composer and has performed internationally both solo and with groups. He resides in Bloomfield Hills, Michigan. Email: email@example.com