Donald Trump has been telling everyone that he’s going to cut business taxes to 15% and make up the reduction in federal income by introducing a consumption tax. According to him, this will kick start the US economy and bring back well-paid jobs. He has support for his plan in the Republican House and Senate, so it’s likely to happen in some form.
The Trump formula, at its core, is the debunked theory of trickle-down economics. Trickle-down economics seems logical but analysis and history show it doesn’t work.
The logic goes that you increase an employer’s income and the employer will spend the extra on creating more jobs. That will reduce unemployment and increase the average income. Thus, the spending power of citizens increases and the government will regain their lost funds via income and the new consumption taxes. Sounds good right?
The trouble is, trickle-down economics relies on employers using the extra money they get from tax cuts to create jobs. However, that only happens if they have been unable to meet demand with their current income. In the United States, that it not currently the situation.
Trump has used the coal industry as an example. He says that reducing taxes and regulations will revive the industry and get miners back to work. It will not. Coal is a dying industry, and promising to revive it is like promising to create thousands of new jobs for farriers. Worldwide coal prices are at historical lows. Nobody wants to buy coal, therefore there is no point in producing it. It makes no difference what Trump does unless he plans to buy it all himself.
The So-Called “War on Coal”
In coal country, especially West Virginia, Kentucky, and Pennsylvania, Donald Trump attracted voters away from the Democratic Party by promising them he’d get them their jobs back. The trouble is, this is not possible. As so often with Trump, the promise is a lie. A report in Time sets out some of the reasons:
Total coal production in U.S. mines declined to about 900 millions [sic] last year, only three-quarters of production in 2008, according to EIA [Energy Information Administration] data.
Coal also struggles to compete with renewable energy sources like wind and solar in locations where those resources are abundant. The cost of solar panels in particular has declined precipitously thanks to technology advances in recent years. Even conservative states like Texas and Oklahoma have become fast adopters of widely available wind energy.
“Trump is not going to bring all the coal jobs back,” says Jason Bordoff, founding director of the Center on Global Energy Policy at Columbia University. “There isn’t a lot of investment activity because in some cases it looks more economically attractive for firms to invest in cleaner technologies.”
Beyond the competition jobs in the coal industry have also disappeared in recent decades as a result of mechanization that began in the 1980s. Approximately 50,000 coal-related jobs have been lost between 2008 and 2012, according to a study from last year. Even if coal production increased, those jobs would not return.
Moody’s Liquidity Stress Index
Moody’s Investors Service analyses multiple economic indicators worldwide. They announced on 2 December that the US Liquidity Stress Index had fallen in November for the seventh month in a row to 6%. That is its lowest level for over a year. Moody’s tells us:
Moody’s Liquidity-Stress Index falls when corporate liquidity appears to improve and rises when it appears to weaken.
Basically, what this means is that US businesses have enough money operate in the current environment, and this situation has been improving for some time. In other words, it is not lack of funds that is preventing businesses from expanding and therefore tax cuts won’t change anything.
In addition, most of the companies who have liquidity difficulties are in the oil and gas sector. Their problem is the current low price for oil internationally; tax cuts won’t help them either.
However, many companies are hoarding their cash overseas to avoid paying tax on it. Estimates are that at least US$2.5 trillion is held outside the country. A law that enabled companies to bring that cash back into the country at a reduced tax rate may have a positive effect. At the very least, if it was held in US banks it would be available for borrowing. It’s something both parties have been talking about, and one party holding all three branches of government should allow it to happen.
Investment in Infrastructure
That money though could also artificially raise the value of the stock market, which is already at record highs. A big reason for this is the lack of other investment opportunities, which the Trump administration could create. The country is in dire need of quality infrastructure projects. Amazingly, the US has no ports capable of handling the latest, biggest class of container ships. Roads, bridges, airports, inner-city schools, and low-cost housing are all areas that need significant work. Trump has spoken of investing in infrastructure, and this would be a positive move. It would create jobs “big league.” Obama tried to do some of this, but was blocked by a Republican congress. Perhaps Trump would have more luck.
However, his focus is his “big, beautiful wall” on the southern border. This does not meet the criteria of “quality” infrastructure project. Former Secretary of Labour Robert Reich states that the best estimate he has seen of the cost of the wall is US$28 billion. He points out it is not necessary because the situation on the border has improved significantly in the last eight years and crossing are now at their lowest level since the early 1970s.
Part of the reason for the success is there has been significant cooperation between the Obama Administration and Mexico. The Trump approach to diplomacy is such that the good relationship between the two countries is damaged before he’s even in office. His demand that Mexico pay for the wall is not only counter-productive diplomatically, it will increase costs of goods coming from Mexico for US citizens.
The Jobs President
Donald Trump tells USians he, “will be the the greatest jobs president God ever created.” His plan will not only not create jobs, it’s not actually unemployment that’s the problem. Unemployment has been steadily reducing since it hit a high of 10% in October 2009. It currently stands at 4.6% (Nov 2016).
The US unemployment rate is low by international standards. It is just below the OECD average, and significantly below the international average.
Unemployment is not currently a problem in the United States, but it could be. Trump’s tax cuts for businesses coupled with a new consumption tax are more likely to cause unemployment than reduce it.
Why Is Unemployment More Likely To Rise?
The people who will initially have more money following a tax cut are the business owners. As pointed out above, they don’t need the money to expand their businesses. Most already have enough to do that if they wanted to. They haven’t done it because there is no demand. There is no point increasing production if you can’t sell the additional product. (I wrote about this at length back in March 2016.) Instead, they will either save the money or invest it in the already bloated stock market. Banks will be cash rich which will depress inflation, and the stock market will become artificially high. This is a problem because:
1. Some inflation is needed to help stimulate the economy and;
2. An artificilly high stock market means a crash will come. That affects everyone because it reduces the value of retirement investments and part of the fallout is a reduction in property values.
Most importantly, Trump plans to pay for this tax cut for businesses with a consumption tax. Presumably this will be like New Zealand’s GST (goods and services tax) or Great Britain’s and Canada’s VAT (value-added tax). There are good reasons to have a consumption tax, and the US federal government is going to need the money. What it will mean in the situation in which it’s being introduced though is a further reduction in demand. The cost of most or all goods will increase with no corresponding decrease in income taxes for most taxpayers. Therefore most people will spend less and demand will decrease.
If people have to spend more on essentials like food, housing, and travel they will have less to spend on other items they deem less essential. Producers of those items will experience a reduction in demand and may have to lay off employees.
The History of Tax Cuts and Unemployment
Income tax cuts for the poor and middle class stimulate growth. That is because they mostly spend the extra income. Tax cuts for the wealthy do not unless they are paying extraordinarily high taxes. It doesn’t matter how many boats, cars, and houses a wealthy person buys. It’s never enough to make up for the number of everyday items bought with the same amount of money spread amongst poor and middle-class people.
The Congressional Budget Office found that the best way to boost economic growth is to extend unemployment benefits. The poor always spend pretty much all of any extra money they receive, which creates demand. The increased demand means employers create more jobs, moving an unemployed person from a government benefit to an income.
Trump isn’t cutting taxes for the poor or middle-class though. He’s increasing them via an indirect tax to pay for a business tax reduction.
Tax cuts for business are useful in times of high unemployment and high inflation but neither of those conditions currently applies in the US.
The “Tax Cuts Increase Revenue” Myth
Trump says tax cuts increase revenue because they increase growth. Here is the history of tax cuts vs growth in the US:
As can be seen, tax cuts have historically decreased revenue in the United States. When taxes on the wealthy are increased to make the tax system more progressive, revenue increases. Enough said really.
If you’re living in the United States, this mic.com article, ‘Your 2017 Money Guide‘ provides some good advice.
If you enjoyed reading this, please consider donating a dollar or two to help keep the site going. Thank you.