23/5/19: Winning the Trade War: Easily and Bigly

NY Fed just published some interesting numbers on President Trump's Trade War with China. Available here: https://libertystreeteconomics.newyorkfed.org/2019/05/new-china-tariffs-increase-costs-to-us-households.html, the Fed note states that per recent study "the 2018 tariffs imposed an annual cost of $419 for the typical household. This cost comprises two components: the first, an added tax burden faced by consumers, and the second, a deadweight or efficiency loss... the tariffs that the United States imposed in 2018 have had complete passthrough into domestic prices of imports, which means that Chinese exporters did not reduce their prices. Hence, U.S. domestic prices at the border have risen one‑for-one with the tariffs levied in that year. Our study also found that a 10 percent tariff reduced import demand by 43 percent."

Thus, in simple terms, China is not paying the tariffs, American consumers are paying the tariffs. Just as Mexico is not paying for the Wall, and just as Mr. Trump is probably not paying his taxes in full (legally or not - a different matter). Same as the Trump Organization is not employing the greatest bestest American workers, preferring to employ cheaper legal and illegal migrants. And same as the Trump Organization is not paying their employees 'tremendous' salaries. And... well, you get the drift.

The Fed note states that, of course, the net loss to the U.S. economy is mitigated by the fact that the tariffs revenue is collected by the Federal Government and "could , in principle, be rebated". Alas, this is of little help to ordinary American households, because the U.S. Federal Government is not particularly know to be efficient spender of the money it collects. One can't really argue that taking $419 from an average household and pumping the cash into, say, new missiles and bombs to be dropped in Yemen is an equivalent economic activity. Or, for that matter, spending the same $419 on fighting in Afghanistan, or subsidizing loss-making perpetually insolvent boatbuilding docks in the U.S. that are already reliant on the atavistic Jones Act to sustain any pretence at building something. And so on... you get the drift.

The Fed researchers go on: "Some firms may also reorganize their supply chains in order to purchase their products from other, cheaper sources. For example, the 10 percent tariffs on Chinese imports might cause some firms to switch their sourcing of products from a Chinese firm offering goods for $100 a unit to a less efficient Vietnamese firm offering the product for $109. In this case, the cost to the importer has risen by nine dollars, but there is no offsetting tariff revenue being paid to the government. This tariff-induced shift in supply chains is therefore called a deadweight or efficiency loss." And the deadweight loss is fully, even in theory - forget practice - carried by the households.

Worse, "economic theory tells us that deadweight losses tend to rise more than proportionally as tariffs rise because importers are induced to shift to ever more expensive sources of supply as the tariffs rise."

How does that work? Marvellously, of course.

"... Compare the estimates of the costs of the 2018 tariffs with those of the recently announced higher tariffs on $200 billion of Chinese products. ...in November 2018, purchasers of imports were paying $3 billion per month in added tax costs and experiencing another $1.4 billion in deadweight losses. Thus, the total bill for U.S. importers was $4.4 billion per month. If we annualize these numbers, they amount to a cost of $52.8 billion, or $414 per household. Of this cost, $282 per household per year was flowing into government coffers as a tax increase and could theoretically be rebated. ... However, deadweight losses accounted for an additional $132 to households per annum and represent a net loss to the U.S. economy that is in excess of any tariff revenue collected by the government."

And the Fed analysis shows the effect of the rising deadweight loss on the U.S. households under the latest bout of tariffs hikes: under 2018 tariffs, deadweight loss was $132 per household per annum, and the total loss to the household was $414 per annum. Under 2019 tariffs, the deadweight loss is estimated to rise to $620 per annum per household and the loss to household budget of $831 per annum.

Now, the Fed study does not take into the account that higher prices charged on consumers as the result of tariffs are also subject to sales taxes imposed at the State level. Which means that for a 7% sales tax state, actual out of pocket losses for 2018-2019 tariffs war for an average household will be in the region of $889 per annum.

Based on the most recent data from the Tax Policy Center, "the middle one-fifth of income earners [in the U.S.] got an average tax cut of $1,090 — about $20 per biweekly paycheck" as a result of 2017 2017 Tax and Jobs Act (TCJA or Trump tax cuts). Transfers from corporate tax cuts to average salaried employee amounted to additional $233 per annum pre-tax. So an average household with two working parents gained somewhere in the neighborhood of $1,330 per annum from the 'massive tax cuts'.

You get $1,330, we take $889 back, and we call it 'America winning the trade war. Easily. And bigly!'

8/5/18: Law of Unintended Consequences and Complexity: Tax Cuts and Jobs Act 2017

The law of unintended consequences (or second order effects, as we call in economics) is ironclad: any policy reform has two sides to the coin, the side of forecasted and analyzed changes the reform engenders, and the side of consequences that appear after the reform has been enacted. The derivative proposition to this theorem is that the first side of the coin is what gets promoted by politicos in selling the reform, while the other side of the coin gets ignored until its consequences smack you in the face.

Behold the U.S. Tax Cuts and Jobs Act 2017, aka Trump's Tax Cuts, aka GOP's Gift for the Rich, aka... whatever you want to call it. Fitch Ratings recently released their analysis of the Act's unintended consequences, the impact the new law is likely to have on U.S. States' fiscal positions. And it is a tough read (see full note here: https://www.fitchratings.com/site/re/10025493).

"Recently enacted federal tax changes (H.R.1) are making budgeting and revenue forecasting more complex for many U.S. state governments," says Fitch. "...provisions including the cap on SALT deductions are a likely trigger behind a spike in state revenue collections for the current fiscal year. In Massachusetts for example, individual income tax collections through January 2018 were up nearly 12% from the prior year, this after the commonwealth recorded just 3% annual growth in January 2017. Many states are seeing robust year-over-year gains in revenue collections, though this will likely amount to little more than a one-time boost with income tax collections set to level off for the rest of the fiscal year."

State tax revenues can increase this year because, for example, of reduced Federal tax liabilities faced by households. As income tax at federal level falls, State tax deductions taken by households on their personal income for Federal tax liabilities will also fall, resulting in an increase in tax revenues to the States. Similarly, as Federal corporate income tax falls, and, assuming, corporate income rises, States will be able to collect increased revenues from the corporate activity domiciled in their jurisdictions. All of this implies higher tax revenues for the States. Offsetting these higher tax revenues, the Federal Government transfers to the individual states will likely decline as deficits balloon and as Pentagon demands an ever-greater share of Federal Budget.

In other words, the tax cuts are working, but do not expect these to continue working into the future. Or put differently, don't spend one-off revenue increases, folks. For high-spending States, like California, it is tempting to throw new money onto old bonfires, increasing allocations to public pensions and state hiring programs. But 2017 Tax Reform is a combination of permanent and temporary measures, with the latter more dominant than the former. Expiration of these measures, as well as complex interaction between various tax measures, suggest that the longer term effect of the Act on States' finances is not predictable and cannot be expected to remain in place indefinitely.

As Fitch noted: "Assessing the long-term implications of H.R. 1 will not be an easy task due to the complicated interrelationships of the law changes and because many of the provisions are scheduled to expire within the next decade. Yet-to-be finalized federal regulations around the tax bill and the possibility of additional federal legislation add more complexity and risk for states."

3/4/3014: Tax or Not: Sunday Times, March 9, 2014

This is unedited version of my Sunday Times article from March 9, 2014


Speaking at last week's Fine Gael Ard Fheis, Minister for Finance, Michael Noonan, T.D. noted that "As a Government, we know that there are further opportunities in the years ahead for us to build upon the initiatives that have worked.  It is in this vein that …I will consider the introduction of targeted tax reductions that have a demonstrable effect on employment growth."

With these words, Minister Noonan finally set to rest the debates as to the Government intentions with respect to core policies for 2015 and thereafter. Whether you like his prior policies or not, he makes a good point: Ireland needs a tax-focused policy intervention. And we need an intervention that simultaneously addresses the declines in after-tax household incomes endured during the current crisis, and does not trigger rapid wage inflation and jobs destruction that can be associated with centralised wage bargaining. The window for an effective intervention is now, in part because as recent evidence shows, fiscal policy effectiveness is greater at the time of near-zero interest rates. But beyond an intervention, Ireland needs a longer-term reform of taxation system.


In general, any economic policy can be judged on the basis of two core questions. Firstly, does the policy offer the most effective means for achieving the stated objective? Secondly, is the policy feasible in economic and political terms?

Reducing income tax burden for lower and middle class earners yields an affirmative answer to all three of the above questions. No other alternative proposed to-date – a cut in VAT rate, a reduction in property tax burden, or an increase in public spending on core services to alleviate cost pressures on families – fits the bill.


Starting from the top, cutting income-related taxes in the current environment makes perfect sense from the point of view of economics.

The three stumbling blocks on our path to the recovery are anaemic domestic consumption, high burden of household debts, and collapsed domestic investment. All of them are interlinked, and all relate to low after-tax disposable incomes. But the last two further reinforce each other. High levels of household debt currently impede restart of domestic investment by both households and firms. They also act as partial constraints on our banks ability to lend. Meanwhile, low domestic investment implies depressed household incomes and high unemployment. In other words, reducing private debt and simultaneously increasing domestic investment should be a core priority for the Government.

On the other side of the national accounts equation, stimulating private consumption offers a weak alternative to the above measures. Due to high imports content of our average consumption basket most of the discretionary spending by Irish households goes to stimulate foreign exporters into Ireland. And it is this discretionary imports-linked spending, as opposed to consumption of non-discretionary goods and services, that has taken a major hit during the Great Recession. Beyond this, higher domestic consumption will do little to raise our SMEs exporting potential, in contrast with increased investment.

Take a quick look at the top-line figures from the national accounts. Based on data from Q1 1997 through Q3 2013, cumulative decline in personal consumption of goods and services over the current crisis amounts to roughly EUR5 billion, when compared against the already sky-high 2004-2008 trend. For gross fixed capital formation - a proxy for investment and capital spending - the cumulative shortfall is EUR50 billion against the 2000-2004 trend, which excludes peak of the asset bubble period of 2005-2007. Put differently, compared to peak, private consumption was down 12 percent in 2013 (based on Q1-Q3 data), while gross investment was down 65 percent. If in 2013 our personal consumption is likely to have returned to the levels last seen around 2005-2006, our investment will be running closer to the levels last witnessed in 1997-1998.

More significantly, lending to Irish non-financial, non-property SMEs has fallen 6.2 percent year-on-year at the end of 2013, as compared to 5 percent for the same period of 2012, according to the latest data from the Central Bank. Meanwhile, value of retail sales was down only 0.1 percent in 2013, according to CSO. Things are getting worse, not better, in terms of productive investment.

It is, therefore, patently clear that an optimal policy to support domestic growth in the economy should target increases in the disposable income of households and incentivise investment and savings ahead of stimulating consumption. It is also clear that such increases should be distributed across as broad of the segment of working population as possible.

To achieve this, the Government can reduce the burden of personal income taxation.

Alternatively it can attempt to target a reduction in the cost of provision of non-discretionary services, such as childcare, health, basic transport and education. In fact, the main arguments against lower taxes advanced by the Irish Trade Unions and other Social Partners are based on the idea that such costs reduction is possible were the state to invest taxpayers funds in further development of these services as well as provide subsidies to supply them to the broad public.

Alas, in practice, Irish public sector is woefully poor at delivering value-for-money. Since 2007 through 2013, inflation in our health services outpaced the general price increases across the economy by a factor of 5 to 1, in transport sector by 3 to 1 and in our education by 12 to 1. Pumping more money into provision of public services might be a good idea when it comes to achieving some social objectives. It is certainly a great idea if we want to stimulate public sector employment and pay, as well as returns to various consultancies and state advisers. But it is not a good policy for helping households to pay down their debts, increase their savings, investment and/or consumption.


Which brings us to the questions of economic and political feasibility of tax reforms.

This week, the Finance Minister confirmed that he will "try to begin the process of making the income tax code more jobs friendly" starting with Budget 2015. Most likely, the next Budget will consider moving the threshold for application of the upper marginal tax rate, currently set at EUR32,800. Minister Noonan described this threshold as being "totally out of line with the practice effectively all over the world, but particularly in Europe." And he's got the point. Across a sample of twenty-one advanced economies, including Ireland, the average effective upper marginal tax rate, inclusive of core social security taxes, currently stands at around 44.4 percent. In Ireland, according to KPMG, the comparable upper marginal tax rate is 48 percent. But an average income threshold at which the upper marginal tax rate kicks in is EUR136,691 in the advanced economies, or more than four times higher than in Ireland.

Widening the band at which the upper marginal tax rate applies to double the current Irish average earnings will mean raising the threshold to EUR71,500 per person per annum. This should be our policy target over the long-term, through 2019-2020.

However, given current income tax revenues dynamics delivering this target today will trigger significant fall-offs in income tax revenues. Data through February 2014, admittedly a very early indicator, shows effectively flat income tax receipts, despite large increases in employment in recent months. In other words, brining our upper rate threshold closer to being in line with the advanced economies average is, for now, a non-starter from fiscal sustainability point of view.

But gradually, over 2015-2016, increasing the 20% tax rate band to around EUR38,000-40,000 should be fiscally feasible, assuming the economy continues to improve as currently projected. This will leave those at or below the average earnings outside the upper marginal tax rate. But it will also provide relief to all those earning above average wages. In other words, widening the lower rate band will generate a broadly-based measure, with likely support amongst the voters.

At the same time, it will also yield significant gains in economic stimulus terms. At the lower end of the targeted band, such a measure would be financially equivalent to a tax rebate of around double the average residential property tax bill.

More importantly, widening the lower tax band will provide for an effective stimulus to the economy compared to all of the above measures. The reason for this is that unlike property tax and VAT, income taxes create economic disincentives to supplying more work effort in the market place. This effect is most pronounced for second earners, self-employed, sole traders and small business owners – all of whom represent core pool of potential entrepreneurs and future employers.

In addition, reducing income taxes, as opposed to consumption and property taxes provides both financial and behavioural support for investment, and savings for ordinary families. A number of studies of consumer behaviour show that savings achieved from the reductions in consumption taxes are commonly rolled up into higher consumption. On the other hand, higher after-tax labour incomes are associated with greater savings, investment and/or faster debt pay-downs.


Beyond widening the standard rate band, the Government can do little at the moment to stimulate disposable income of the households. Yet, in the longer term, we face the need for a more comprehensive and deeper reform of our tax system. Critical objective of such reform is to achieve a new system for funding the state that relies less on income tax and more on direct user-fees charges for goods and services supplied to consumers, plus taxes on less productive forms of capital, such as land, property and speculative assets. Changes in the underlying drivers for growth in the Irish economy will also necessitate tightening of corporate and income tax loopholes. This should lead to increased reliance by the state on corporate tax revenues, while freeing some room for the reduction in tax rates. In targeting these, the Government should focus on the upper marginal tax rate itself.

Designed with care and delivered with caution, such reforms can put Irish economy on the path of higher growth well anchored in the underlying fundamentals of our society: indigenous entrepreneurship, domestic investment and skills-rich workforce.

Box-out:

This week, the EU Commission published its 2014 Innovation Union Scorecard showing comparative assessment of the research and innovation performance across the EU. The good news is that Irish rankings in the area of innovation have improved from 10th to 9th over the last twelve months - not a mean task given our tight economic conditions and scarcity of funds across the economy. The bad news is that we are still ranked as 'innovation follower' and that our performance is still weak when it comes to developing a thriving innovation culture in the SME sector. As experience from the UK shows, just a couple of simple changes to Ireland's tax codes can help us enhance the incentives for SMEs to develop a more active innovation and research culture. We need to reform our employee share ownership structures to make it easier for smaller companies and entrepreneurs to attract key research personnel and promote innovation within enterprise. For example, in Ireland, employees securing an equity stake in the business employing them currently face an immediate tax liability, irrespective of the fact that they receive zero financial gain from the shares until these as sold. This applies also to smaller start-up ventures, particularly the Universities-based research labs. Thus, a researcher working in Ireland's high potential start-up or a research lab can face a tax liability on owning the right to a yet-to-be-completed research they are carrying out. This is not the case across the Irish Sea and in the Northern Ireland. In 2012-2013, the UK Government adopted 28 new policies aimed at promoting various forms of Employee Financial Involvement (EFI) in the companies that employ them. The UK has allocated £50 million through 2016 to promote public awareness of the EFI schemes and is actively working on reducing the administrative burden for companies and employees relating to EFI. It is a high time we in Ireland have followed our neighbours lead, lest we are content with remaining an 'innovation follower' in the EU for years to come.

24/10/2013: Fiscal Policy: To Bail Directly or Via Project Finance?

New paper "Macro Fiscal Policy in Economic Unions: States as Agents" by Gerald Carlino, and Robert P. Inman (NBER Working Paper No. 19559 published October 2013) argues that ARRA (the American Recovery and Reinvestment Act) was the US government’s fiscal policy (as opposed to monetary policy QEs programmes) response to the Great Recession. "An important component of ARRA’s $796 billion proposed budget was $318 billion in fiscal assistance to state and local governments."

The study "reaches three conclusions.

1. "First, aggregate federal transfers to state and local governments are less stimulative than are transfers to households and firms. It is important to evaluate the two policies separately." Note: I have argued that in the current extreme case of debt overhang on household side, monetary policy can act directly to monetize debt (effectively cover household debt write downs) instead of attempting tod sliver support for deleveraging via traditional channels (banks --> firms & households, or government --> firms & households).
2. "Second, within intergovernmental transfers, matching (price) transfers for welfare spending are more effective for stimulating GDP growth than are unconstrained (income) transfers for project spending. Matching aid is fully spent on welfare services or middle-class tax relief; half of project aid is saved and only slowly spent in future years." Again, direct injections to households will work better than indirect stimulus via 'infrastructure projects' or neo-Keynesian 'digging of the trenches'… However, this effect for the US is obviously linked to the less open nature of the US economy than say in the case of smaller economies of Europe.
3. "Third, simulations using the SVAR specification suggest ARRA assistance would have been 30 percent more effective in stimulating GDP growth had the share spent on government purchases and project aid been fully allocated to private sector tax relief and to matching aid to states for lower-income support."

From the paper: Federal Aid, Federal Purchases, and Federal Net Revenue: 1947 - 2010*
(Per Capita, 2005 Dollars)

Now, look at the above and give a thought to the fact that Paul Krugman still thinks there was not enough stimulus...