The President's Rotten Record on Trade
Why George W. Bush is the most protectionist president since Herbert Hoover
Herbert Hoover is rightly reviled for having the worst record on international trade of any president. The Smoot-Hawley Tariff, which Hoover signed into law in 1930 after a Republican Congress passed it, was a significant factor in deepening the Great Depression. Since then, every president has embraced at least the rhetoric of free trade. But actions and rhetoric are different things, and George W. Bush in particular has preached free trade while advancing the agenda of a petty protectionist.
In so doing, he’s returning his party to its roots. From Lincoln through Hoover, a high tariff on imported manufactured goods was the foundation of Republican trade policy. The Democrats, as the party of the workingman, backed free trade. They understood that tariffs raised the prices of goods, fattened the profits of politically connected businessmen, and acted like a tax on the poor.
After Smoot-Hawley led to a collapse of world trade and helped sow the seeds of World War II, a bipartisan anti-protectionist consensus emerged. Protection, it was understood, could lead to tit-for-tat retaliation by other countries that might explode into a trade war or even a shooting war. One of Franklin Roosevelt’s first acts in office was to reverse Smoot-Hawley. He later insisted that freer trade be a key element of postwar planning, which led to the creation of the General Agreement on Tariffs and Trade. Harry Truman required nations receiving Marshall Plan aid to adopt free trade policies, a decision that probably did more to revive Europe’s economies than the aid itself. Dwight Eisenhower supported creation of the Organization for Economic Cooperation and Development to help maintain free trade among major industrialized countries.
From then on every president had a hand in liberalizing world trade. John Kennedy initiated a round of multilateral trade negotiations, concluded under Lyndon Johnson, that eventually led to a reduction in world tariff levels by about a third. Under Richard Nixon, another round of trade negotiations began, known as the Tokyo Round, which Jimmy Carter finally pushed through an increasingly protectionist Democratic Congress in 1979.
Slowing Down Fast Track
By the 1980s, the parties had largely reversed their historical positions on trade. The Democrats, especially in Congress, had come to view protectionism as a way to protect jobs for working people rather than as a tax on them. And with American businesses becoming increasingly multinational, Republicans now saw free trade and access to foreign markets as central to their constituency. Ronald Reagan initiated talks with Canada and Mexico on establishing a North American free trade zone and inaugurated another multilateral trade negotiation known as the Uruguay Round. George H.W. Bush pushed forward negotiations on both the Uruguay Round and the North American Free Trade Agreement, known as NAFTA. Bill Clinton concluded the Uruguay Round and rammed NAFTA through Congress despite strong resistance from his own party.
George W. Bush came into office hoping to expand world trade by further breaking down barriers, which increasingly take the form of subsidies that distort prices and create an unlevel playing field. His first U.S. trade representative, Bob Zoellick, was widely known for his commitment to open markets and was anxious to start a new round of trade negotiations.
But before negotiations can begin, Congress has to give the president negotiating authority, sometimes called fast-track authority. The president could negotiate whatever he wants and then submit it to Congress for approval.
But without negotiating authority in advance, such an effort likely would succumb to the inevitable amendments and filibusters. Fast-track authority gets Congress to bind itself to granting an up-or-down vote on the package at the end of the process, with no further political gamesmanship.
In 2001 Congress was not in the mood to grant that authority. Democrats were against anything that would either expand trade (and thus, in their opinion, threaten American jobs) or help Bush, whose election many considered illegitimate. GOP control of Congress was very thin, and with the economy in recession many Republicans were skittish about voting to promote trade if it might be seen as threatening domestic jobs.
Republicans in the steel-producing districts of Pennsylvania, Ohio, and West Virginia were especially fearful of electoral retaliation. They demanded that Bush do something to help the steel industry as the price for their vote on trade-negotiating authority.
In June 2001, Bush initiated an investigation by the U.S. International Trade Commission into whether the steel industry was being injured by imports. It was virtually preordained that the commission would find such injury, because of the low legal threshold for such a determination. The commission did indeed find injury in December. Under the law, President Bush had until March to decide what actions he would take to protect the steel industry.
At the same time, Republicans from agricultural areas were complaining about low farm prices and demanding more subsidies, even though Bush had promised to move toward a more market-based agricultural system during the 2000 campaign. It was vital Bush do the right thing on the 2002 agriculture bill because the whole point of the trade negotiations, known as the Doha Round, was to remove subsidies for agriculture, which cost taxpayers in the industrialized countries dearly while making it impossible for farmers in the developing world to compete and better themselves.
In both cases, Bush made exactly the wrong decision.
George W. Bush, Man of Steel
Only one justification for trade protection has widespread support among economists: to preserve “infant” industries, those just getting started and competing against well-established rivals. So it is ironic that the American industry that has sought and received the most protection over the years is not a new one, such as electronics or software, but the quintessential old industry: steel. It is always just on the verge of being competitive, the industry swears, and only needs a little breathing space to invest and modernize. Then tariffs and quotas can be relaxed.
But that day never comes. Since 1969 the U.S. steel industry has received continuous protection in one form or another. These barriers have cost U.S. consumers between $104 billion and $175 billion more (in constant 2006 dollars) for products made with steel, such as automobiles and appliances.
Many academic studies have concluded that steel industry protection has done nothing to improve its competitiveness. The higher prices simply raise industry profits or reduce its losses—and reduce incentives to innovate. Despite that, many analysts who usually support free trade have made an exception for steel on national security grounds, arguing that we need adequate domestic manufacturing capability to build ships and tanks in the event of war. But today’s weaponry depends much more on high-tech composite materials than on ordinary steel. According to an October 2001 Commerce Department study, no weapons system is dependent on imported steel; there will be more than sufficient domestic capacity for all Defense Department needs for the foreseeable future; and there are far cheaper ways of ensuring the Pentagon’s needs than through trade protection.
In late 2001 the Doha Round officially started. But well into 2002, the U.S. could not meaningfully participate because Congress had yet to pass fast-track authority. Steel and agriculture were the hang-ups.
On March 5, 2002, Bush sought to assuage those concerned about steel by imposing a 30 percent tariff on steel imports. In an amazing example of doublespeak, Trade Representative Zoellick explained that this was a major step toward free trade. The tariffs, he said, would compensate for government subsidies often given to foreign steel producers. Most observers saw Bush’s action as nothing but buying a few votes in politically important swing states.
The Europeans and Japanese immediately drew up lists of American goods they’d subject to retaliatory tariffs. On a trip to Beijing in April, hoping to open the Chinese market to more U.S. exports, Zoellick found Chinese officials unresponsive. Why should they open their market, they asked, when the United States was in the process of closing its own?
The Wall Street Journal worried that Bush’s direction on steel was weakening his ability to influence other countries on a variety of issues. “The policy mattered less than the abandonment of principle,” it editorialized. “It signaled to the world that Mr. Bush was not the president he had seemed after September 11; his moral and strategic clarity could be compromised for a price.”
By summer, a wide variety of steel-using businesses in the U.S. were complaining about a cost squeeze. Their raw material cost had risen by 30 percent, but they were unable to raise their own prices to compensate. This was especially the case for businesses facing international competition, since finished goods made with steel were not subject to the tariffs. Hence the tariffs put U.S. manufacturers at a competitive disadvantage in both domestic and foreign markets.
Bush’s steel policy probably did get him the last couple of votes he needed in the House to get trade promotion authority, so that the U.S. could finally participate meaningfully in the ongoing Doha Round. On July 27, 2002, 215 House members voted for the conference report on the trade bill, while 212 voted against it.
By January 2003, the steel tariffs had cost far more jobs in steel-using businesses than could possibly have been saved among steel producers. According to the economists Joseph Francois and Laura Baughman, 200,000 jobs had been lost among steel users. There were only 187,500 total jobs in the steel industry itself. Substantial numbers of manufacturers had been forced to move their production outside the U.S. to escape the tariffs. It is unlikely these outsourced jobs will return.
In a September 2003 study, the International Trade Commission concluded that the steel protection policy had been a net loss for the country, calculating that, on balance, the nation was worse off to the tune of $42 million. Furthermore, in May 2003 the World Trade Organization had ruled that the steel tariffs were illegal under world trade law. After a U.S. appeal was rejected, the European Union prepared to impose retaliatory tariffs on U.S. goods.
In December 2003, Bush finally bowed to reality and lifted the tariffs. But he continued to pay a heavy price in the Doha talks, as other countries repeatedly rejected American entreaties to lower their barriers to U.S. goods. As The Wall Street Journal put it, “When the world’s main economic power indulges in protectionism, everyone else figures it’s safe to do the same.”
Dooming Doha
Congress traditionally produces a farm bill every five years. The 1996 law had eliminated a number of subsidies and regulations, but its 2001 successor was a return to the older, subsidy-heavy approach. The final bill, signed by Bush in May 2002, raised spending by almost $90 billion above the previous law; the Congressional Budget Office estimated that it cost $470 billion over five years.
The importance of the new agriculture subsidies went well beyond the burden on the budget or the impact on farmers. They basically doomed the Doha trade talks, which were primarily about reducing farm subsidies worldwide—especially in Europe, where farmers are even more politically powerful than they are here.
When pushing for the new trade round, the United States had enthusiastically endorsed farm subsidy reductions, believing they would increase U.S. exports. But the only hope of achieving meaningful cuts in agricultural subsidies lay in appealing to the basic principle that such payouts are wrong—that they are costly, inefficient, and a poorly targeted way to help farmers, with much of the money going to people who are already well-to-do. By working together with the few other countries that generally support free trade, such as Australia, it might have been possible to shame the Europeans into making some kind of deal. But when Bush signed a massive increase in U.S. subsidies right at the start of the trade talks, he lost all credibility.
It didn’t help that the Bush administration also alienated Canada, another of the small band of free traders, by slapping a 29 percent tariff on Canadian lumber in March 2002. Not only did this raise the cost of homebuilding in the U.S.; it also led Canada to retaliate with a 71 percent tariff on U.S. tomato exports.
Another sad consequence of failing to curb agricultural subsidies is the further impoverishment of farmers in the less developed countries. By forcing down prices for agricultural products, subsidies drive many poor farmers out of business, making them dependent on food aid from the West.
The Bush trade mavens were willing to pick fights with anyone in the name of protection, including the supposedly dangerous superpower-in-training China. On November 18, 2003, the Bush administration announced a decision to impose new trade restrictions on imports of Chinese textiles. A petition from four textile industry groups, led by South Carolina Republican textile magnate Roger Milliken, got that ball rolling. It claimed Chinese imports “threatened to impede the orderly development of trade and caused market disruption in the U.S.” No proof was offered to support this allegation.
To show just how absurd the situation was, one of the new restrictions applied to brassieres. Yet there is no domestic manufacturer of this product. Some components are produced in the United States, but all are exported to low-wage countries in Latin America for manufacture. This is done solely because of a law requiring a degree of domestic content to avoid trade barriers when the final product is imported. The reality is that 100 percent of brassieres are imported. There’s no domestic industry to protect.
The day after the U.S. textiles decision, China canceled a trade mission to the United States that probably would have led to billions of dollars in orders for American goods. In previous weeks China had signaled a desire to increase its imports of planes from Boeing, jet engines from General Electric, and a variety of agricultural products as well as chemical and telecommunications equipment. Such purchases likely would have been greater than the value of the goods that were now restricted, creating vastly more jobs—and better-paying ones—than those protected in the textiles industry.
The Problem With Bilateralism
After the de facto collapse of the Doha Round, the Bush administration turned toward free trade agreements (FTAs) with individual countries or small groups of countries. Economists are dubious about the value of such agreements, which were often less about free trade than about pursuing new avenues for U.S. protectionism.
Before 2001 the U.S. had free trade agreements only with Israel, and with Canada and Mexico through NAFTA. In 2001 Bush signed an agreement with Jordan. In 2002 he initiated talks with Australia, Chile, Singapore, and five Central American countries (Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua). In 2003 his administration successfully concluded negotiations with Singapore and Chile and began new talks with Morocco, Bahrain, four Andean nations (Colombia, Peru, Ecuador, and Bolivia), and five Southern African ones (Botswana, Lesotho, Namibia, South Africa, and Swaziland). In 2004 the talks with the Central American countries (to which the Dominican Republic was added) and Australia were completed.
Although the amount of activity involved in pursuing FTAs was certainly impressive, economists had serious doubts about their value. “Nearly all scholars of international economics today are fiercely skeptical, even hostile, to such agreements,” the Columbia University economists Jagdish Bhagwati and Arvind Panagariya argue in the Financial Times.
Key reasons for this hostility are that bilateral agreements—and smaller multilateral agreements, such as the Central American pact—divert attention and resources from multilateral agreements, which are vastly preferable. FTAs may divert trade flows rather than increase them and may lead trade blocs to impose restrictions on trade with those outside the bloc, thus raising the overall level of protection. Supporters of FTAs mostly argue that they are better than nothing and may provide building blocks for broader trade agreements. No one believes that FTAs are optimal trade policy.
Nevertheless, FTAs have become almost the sole Bush administration effort to open trade. Even while doing so, it has often used such agreements to pursue protectionist objectives. An especially egregious example of this is when the administration nearly scuttled the free trade agreement with Australia in order to maintain protection for the sugar industry, despite universal condemnation of the sugar program, which adds some $2 billion per year to consumer costs, mainly to enrich a few Florida producers.
According to the Financial Times, George W. Bush personally made the decision to exclude Australian sugar from the FTA. This became the first such agreement ever negotiated to exclude an individual product from its provisions. The New York Times spoke for many. “The agreement sends a chilling message to the rest of the world,” it said. “Even when dealing with an allied nation with similar living standards, the administration…has opted to continue coddling the sugar lobby, rather than dropping the most indefensible form of protectionism. This will only embolden those around the world who argue that globalization is a rigged game.”
In early 2005, the Bush administration put enormous pressure on Congress to approve the Central American Free Trade Agreement (CAFTA). Although the economic benefits from this agreement were quite modest, the administration had little choice but to press hard for its passage in order to salvage some semblance of a trade agenda. But the price for passage was very high, with Republicans demanding restrictions on Chinese imports in exchange for their votes. Consequently there was very little likelihood that its passage would lead to a net reduction in trade barriers.
CAFTA also proved costly to taxpayers, because the administration was forced to agree to many new pork barrel projects in order to buy the last couple of votes to squeak it through; CAFTA passed the House by a razor-thin margin of 217 to 215 on July 28, 2005. Free traders worry this precedent will encourage members of Congress to demand even more payoffs for future votes.
The Dumping Delusion
Although Bush and his team have shown contempt for overarching free trade principles pretty much every step of the way, the administration excuses a lot of the new trade protection on its watch by saying it’s mandated by existing law, especially “anti-dumping” laws that require the imposition of tariffs and give the president no latitude. There is some truth to this defense. But in many cases the Bush administration has simply used anti-dumping statutes as backdoor protectionism that could have been resisted if it had chosen to do so.
The term dumping is commonly understood to mean selling foreign products at below cost, possibly because of subsidies from the producers’ governments. But legally speaking, dumping exists simply when a product is sold in the U.S. for less than it is sold for in other markets. No evidence is needed that the product is being sold below cost or that any subsidy is involved.
Although dumping is assumed to be unfair when it involves international trade, a business might sell products at seemingly unprofitable prices for many reasons commonly accepted as reasonable in the domestic market. For example, when introducing a new product against established competition, a company may need to sell at a loss in order to gain a foothold in the market. It may need to dispose of inadvertent overstocks, or it may hope to make a profit through ancillary sales—think of Barbie dolls that are sold cheaply because the real profit is in the clothes.
U.S. businesses often use anti-dumping petitions as a tool to prevent foreign competitors from reducing prices and undercutting the domestic companies’ profits and market share. Even when foreign firms are confident of winning a dumping case, they may not want to go through the effort and expense to defend themselves in what is rightly seen as a biased process. So they back off.
Though the idea that there is something inherently unfair or unjust about dumping has been entrenched in U.S. law for more than 100 years, the law was rarely enforced until the 1970s. At that time it was broadened to allow tariffs even in cases where no dumping was even alleged, as long as imports caused some injury to a domestic industry. Tariffs also could be imposed as retaliation for a foreign country’s restrictions on U.S. exports.
Despite the Bush administration’s claim that many of its tariff decisions are the result of obeying longstanding anti-dumping law, many of these investigations are instigated by the Commerce Department as a matter of policy and are rigged to guarantee that dumping will be found. Almost all of the tariffs imposed on Chinese furniture, Vietnamese shrimp, and other goods have taken place under the guise of anti-dumping enforcement when they are really policy actions. As a consequence, other countries increasingly are using their own anti-dumping laws against American goods. Like all protectionist moves, anti-dumping actions set in motion a domino effect of reactions and restrictions that clog up world markets and ultimately make us all poorer than we otherwise would be.
The New Herbert Hoover
Bush’s overt protectionism may not be that great. But in overall policy, he’s the most protectionist president since Hoover. All of Hoover’s successors until Bush understood the fragility of free trade and the dangers of playing politics with it. They also understood that there is an inherent drift toward protectionism that needs to be vigorously resisted and offset by aggressive trade-opening measures. Bush has gone in the opposite direction, repeatedly using protectionism to buy short-term political support and sabotaging multilateral trade negotiations.
Bush also has treated the World Trade Organization with contempt. He has taken actions that he knew would be ruled illegal, such as the steel tariffs, and made little effort to redress illegaelements of U.S. law, such as the Foreign Sales Corporation tax break and the Byrd Amendment.
The former, which the WTO ruled to be a de facto subsidy, was finally repealed in 2004 with the White House and Treasury Department doing virtually nothing to aid the effort. The latter is a law enacted in 2000 that allows some anti-dumping duties to be paid directly to private businesses—making explicit what is already implicit in anti-dumping measures, which always help specific businesses at the nation’s expense. (According to the Government Accountability Office, half the benefits of this legislation went to just five companies.) The WTO ruled the Byrd Amendment illegal as well.
Under Bush, free trade is probably in its weakest position since the 1920s. The ultimate consequence of Bush’s abandonment of principle may not come on his watch. But thanks to him the dangers associated with protectionism are growing, and they will likely lead to future trade skirmishes and wars that will lower the standard of living of all Americans. Unfortunately, Bush seems comfortable with that legacy.
WHAT IS BEHIND THE INFLATION IN EMERGING MARKETS?
Gary Becker (link) and The Economist (link) recently discussed the surge in commodity prices and inflation that has driven inflation rates in emerging markets as well as in high-income economies to historic highs. For example, China's official rate of consumer price inflation is at 12-year high of 8,5 percent. Unofficial estimates have shown that Argentina's inflation rate has peaked 23 percent in 2008. Also, inflation rate in Russia has trimmed up to 14,5 percent, up from 8 percent annually. Central banks in emerging markets have repeatedly faced significant inflationary pressures. In world market, the price of oil barrel has climbed over $120 USD which gave speculators a boost in inflating the expectations that the world price of oil barrel will reach $200 percent and more.Using the data and some basic tools of economic analysis, it is easily shown that the real price of oil per barrel in relative terms, cannot reach $200 USD unless terrorists attack or a sudden attack on oil fields in the Middle East impairs production abilities of oil producers in that part of the world. Commodity market analysts repeatedly analyze the spillover effects of the regulation of production in oil-exporting economies that generates upward changes in the world price of oil. One reason is that OPEC is a cartel of countries whose profit-making point rests on the real assumption that price elasticity of oil demand is very low which means that there's an inelastic demand for oil. In that case, producers choose to allocate relatively scarce resources by rationing the production of oil and thus increasing the price of oil which, in real conditions of imperfect competition, yields oil producers gains since inelastic consumer demand and quantity control of the production return higher profits when the price per unit of oil is increased. One of the classical solutions to avoid higher price increases and mark-ups is to shift towards the consumption of green energy that will make the demand for commodities, such as oil, more elastic and that would immediately eliminate the monopoly power of OPEC. But the shifts towards "greener energy" is a time-taking process that involves significant consumer expenditures as the price of products that are not linked to oil as production ingredient, is high. That is because, developing "green" products demands huge company expenditures in R&D, supply chains and knowledge-intensive services. Over time, the dependency on oil is expected to decline which implies that cartel stability of OPEC which controls the quantity and price of oil in the world market will decline gradually.
Among economic analysts, the surge in commodity prices is assumed as the engine of current inflationary pressures. But world supply and demand cannot solely explain the surge in commodity product prices. Impeding price controls and export subsidies have vastly contributed to a recent surge in commodity prices. Using price controls causes disparities in quantitiy demanded and supplied which leads to quantity shortages and price accomodation in underground markets. Also, various export bans, subsidies and price controls cause significant micro-inefficiencies that raise the rigidity and potentially reduce the elasticity of demand and supply.
Another important aspect of the surge in inflation in emerging markets is macroeconomic policy pursued by central banks and fiscal policymakers. For example, China responded to inflation surge by putting up more price controls and export bans. India has suspended futures trading in particular commodity markets. In the short run, such measures can cap the official inflation but in the long run, such measures do not lead to price adjustment after the endogenous and/or exogenous shocks tranquil. One of the reasons for an obviously higher inflation rate is that households in emerging markets have higher food expenditure from their budgets which places a heavy weight on food demand, making it more inelastic. Another reason is that central banks in emerging markets such as Russia, China, India and Brasil, pursued an expansionary monetary policy in recent years. Money supply, for example, has grown tremendously. In Russia, for instance, money supply has grown by a swelling 42 percent and central bank's target interest rate (6,5 percent) is far below the official inflation rate (15 percent).
On the offset, rigid labor markets and inflexible wage determination lead to price-wage spiral. An evidence has been observed in Russia where wages are growing 30 percent annually, more than 3 times more than the growth of productivity. A combination of rigid and inflexible market mechanism and expansionary macroeconomic policy as well as supply shocks contributed to the rise in the inflation rate. Even though sound growth forecast, predict a fairly stable output growth rate in the medium term, central banks in emerging markets will have to face the fact that expansionary fiscal policy must be neutralized by a rise in the interest rates and a decrease in the growth of money supply as a neccessary measure to bring the inflation under control. Continued rapid growth in emerging markets means that relative-price shock will be temporary and the food prices will remain high. Also, exchange rate flexibility is needed to avoid intended currency depreciation which sets an important pressure on inflation expectations. Thus, without tighter monetary policy and flexibile labor markets, central banks may soon repeat the mistakes which caused the great inflation in 1970s.
The Problem With the Corporate Tax
GREGORY MANKIEW
AT this point in the presidential campaign, Senator John McCain is the candidate of ideas on issues of tax policy. Too many ideas, in fact. While some of his ideas are great, others are almost laughable.
The one that has received the most attention recently — a gas-tax holiday — falls in the second category. Many economists and policy wonks advocate raising the tax on gasoline to address problems ranging from global climate change to local traffic congestion. It is hard to find one who thinks that a temporary cut in the gas tax is a sensible response to the current spike in gas prices.
Lost in this hubbub, however, is a bigger idea that Mr. McCain and his economic team have put forward: a cut in the corporate tax rate, to 25 percent from 35 percent. It is perhaps the best simple recipe for promoting long-run growth in American living standards.
Cutting corporate taxes is not the kind of idea that normally pops up in presidential campaigns. After all, voters aren’t corporations. Why promise goodies for those who can’t put you in office?
In fact, a corporate rate cut would help a lot of voters, though they might not know it. The most basic lesson about corporate taxes is this: A corporation is not really a taxpayer at all. It is more like a tax collector.
The ultimate payers of the corporate tax are those individuals who have some stake in the company on which the tax is levied. If you own corporate equities, if you work for a corporation or if you buy goods and services from a corporation, you pay part of the corporate income tax. The corporate tax leads to lower returns on capital, lower wages or higher prices — and, most likely, a combination of all three.
A cut in the corporate tax as Mr. McCain proposes would initially give a boost to after-tax profits and stock prices, but the results would not end there. A stronger stock market would lead to more capital investment. More investment would lead to greater productivity. Greater productivity would lead to higher wages for workers and lower prices for customers.
Populist critics deride this train of logic as “trickle-down economics.” But it is more accurate to call it textbook economics. Students in introductory economics courses learn that the burden of a tax does not necessarily stay where the Congress chooses to put it. That lesson is especially relevant when thinking about the corporate tax.
In a 2006 study, the economist William C. Randolph of the Congressional Budget Office estimated who wins and who loses from this tax. He concluded that “domestic labor bears slightly more than 70 percent of the burden.”
Mr. Randolph’s analysis stresses the role of international capital mobility. With savings sloshing around the world in search of the highest returns, he says, “the domestic owners of capital can escape most of the corporate income tax burden when capital is reallocated abroad in response to the tax.” When capital leaves a country, the workers left behind suffer. (According to Mr. Randolph, however, some workers do benefit from the American corporate tax: those abroad who earn higher wages from the inflow of capital.)
A similar result was found in a recent Oxford University study by Wiji Arulampalam, Michael P. Devereux and Giorgia Maffini. After examining data on more than 50,000 companies in nine European countries, they concluded that “a substantial part of the corporation income tax is passed on to the labor force in the form of lower wages,” adding that “in the long-run a $1 increase in the tax bill tends to reduce real wages at the median by 92 cents.”
Despite these findings, a corporate tax cut as a way to help workers may strike some people as needlessly indirect. Why not just pass an income tax cut aimed squarely at working families, as Senator Barack Obama proposes?
The answer is that while most taxes distort incentives and shrink the economic pie, they do not do so equally. Compared with other ways of funding the government, the corporate tax is particularly hard on economic growth. A C.B.O. report in 2005 concluded that the “distortions that the corporate income tax induces are large compared with the revenues that the tax generates.” Reducing these distortions would lead to better-paying jobs.
Of course, a corporate tax cut would affect the federal budget. And any change in tax policy has to be made against a background of a looming fiscal crisis, which threatens to unfold as baby boomers retire and start collecting Social Security and Medicare. In 2007, corporate taxes brought in $370 billion, representing 14 percent of federal revenue. Cutting the rate to 25 percent would seem to cost the Treasury about $100 billion a year.
Part of that revenue loss, however, would be recouped through other taxes. To the extent that shareholders would benefit, they would pay higher taxes on dividends, capital gains and withdrawals from their retirement accounts. To the extent that workers would benefit, they would pay higher payroll and income taxes. Increased economic growth would tend to raise tax revenue from all sources.
SOME economists think that these effects are strong enough to make a corporate rate cut self-financing. A recent study by Alex Brill and Kevin A. Hassett of the American Enterprise Institute, looking at countries in the Organization for Economic Cooperation and Development, supports exactly that conclusion. But even if that turns out to be too optimistic, both theory and evidence make it reasonable to expect a significant discount from the sticker price. In the end, the net budgetary cost of the tax cut might be, say, $50 billion a year.
Senator McCain wants to fill that hole in the budget by restraining spending. If he can stop bloated legislation like the recent $300 billion farm bill from becoming law, more power to him.
But in case that quest proves quixotic, I have a back-up plan for him: increase the gasoline tax. With Americans consuming about 140 billion gallons of gasoline a year, a gas-tax increase of about 40 cents a gallon could fund a corporate rate cut, fostering economic growth and reducing a variety of driving-related problems.
Indeed, if we increased the tax on gasoline to the level that many experts consider optimal, we could raise enough revenue to eliminate the corporate income tax. And the price at the pump would still be far lower in the United States than in much of Europe.
Don’t laugh. I’m serious.
June 13 (Bloomberg) -- The world's most powerful governments are looking for ways to boost economic growth to compensate for record oil prices, just as central bankers gird for an inflation fight.
French President Nicolas Sarkozy wants to cap value-added taxes on fuel, the U.K. is cutting taxes for energy producers and Japan is helping truckers. Italy is threatening a levy on oil companies, while in the U.S., Democratic presidential candidate Barack Obama is calling for a second economic stimulus package.
Finance ministers from Group of Eight countries gather in Osaka today and tomorrow after the price of crude oil doubled in the past year to reach a record $139.12 on June 6. While they try to stave off a global recession, central bankers are turning their attention to quashing price increases after 10 months of defending the expansion from a credit squeeze.
``Inflation means central banks aren't in a position to provide great relief to growth,'' said David Hensley, director of global economic coordination at JPMorgan Chase & Co. in New York. ``There's going to be mounting pressure on governments to respond decisively.''
The International Monetary Fund in April predicted advanced economies this year will suffer their fastest price gains since 1995 and their weakest expansion in seven years. The World Bank said June 10 that global growth will slow a percentage point to 2.7 percent in 2008.
Bernanke Signal
Federal Reserve Chairman Ben S. Bernanke on June 9 delivered his clearest message yet that the central bank is done lowering interest rates after 3.25 percentage points of cuts since September, saying officials will ``strongly resist'' any surge in inflation expectations. European Central Bank President Jean-Claude Trichet said June 5 he may raise rates in July.
``What was a threat about half a year ago now appears to have become a reality -- stagflation,'' said Joachim Fels, co- chief economist at Morgan Stanley in London.
That leaves it to politicians to defend growth, and their own political standing, as U.K. motorcyclists and French taxi drivers protest rising fuel bills and consumers bemoan falling purchasing power.
`Very Worried'
``Governments are very worried about the impact of inflation economically and politically,'' said Klaus Baader, chief European economist at Merrill Lynch & Co. in London. ``They're going to take more and more compensatory action.''
Ed Gillespie, President George W. Bush's counselor, said June 6 the U.S. is ``constantly looking at options and proposals'' even after it began mailing more than $100 billion in tax-rebate checks. Four days later, Keith Hennessey, director of the White House National Economic Council, said the Bush administration is opposed to another stimulus package.
U.K. Prime Minister Gordon Brown last month relaxed taxes on some North Sea oil production sites in an effort to lift output and is facing calls to delay an increase in fuel duties and reverse a doubling of taxes for some cars.
Sarkozy is renewing energy-tax rebates for farmers and has proposed cutting the VAT on fuel, ignoring opposition from neighbors in the European Union.
Italian Prime Minister Silvio Berlusconi plans ``targeted'' tax cuts on fuels while Finance Minister Giulio Tremonti last week suggested oil companies be forced to pay a ``Robin Hood'' tax with the revenues being passed to households.
Temporary Relief
Meantime, the Japanese government is spending 215 billion yen ($1.9 billion) through March on easing the burden of higher oil costs on small and midsized enterprises. For trucking businesses, the discount for overnight highway tolls was raised to 40 percent from 30 percent.
While such measures may provide temporary relief, they might also exacerbate the inflation threat by reinforcing energy demand. A windfall tax could also deter companies from investing in exploration.
``Tax policies are not an appropriate means to counter commodity-price increases,'' Trichet said June 5. ``This would send the wrong signals to producers and consumers alike.''
Some G-8 politicians agree. German Finance Minister Peer Steinbrueck, who is not traveling to Osaka, said June 2 that governments shouldn't ``react politically and try to intervene'' to tame oil prices.
Past Failures
That means that as a group, the G-8 may shy away from backing coordinated fiscal responses, instead resorting to repeating past demands that petroleum producers pump more oil and consuming countries become more efficient.
That approach has so far proved unsuccessful. When it was adopted at a May 2004 meeting in New York, oil cost about $40 a barrel. Saudi Arabian Oil Minister Ali al-Naimi on June 9 rejected demands for higher output.
Geoffrey Yu, a currency strategist at UBS AG in Zurich, said the G-8 may also express concern that the falling dollar is fanning inflation. The G-8 ministers have refrained from making a joint comment on exchange rates for two decades as central bankers aren't present at the talks. A Canadian official said June 9 that currencies would not be a major topic.
``It's hard to talk about commodity prices and not the dollar,'' Yu said. Paulson told Bloomberg Television on June 10 that he would tell his counterparts that ``strong'' economic fundamentals will be reflected in the dollar.
The G-8 is composed of the U.S., Japan, Germany, Russia, U.K., Italy, Canada and France.
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