The IMF vs. Greer on Budget Deficits and Trade Deficits
In a recent piece published on the IMF website, U.S. Trade Rep. Jamieson Greer argues that "[t]rade theory must catch up with tariffs, industrial policy, and the costs of globalization." There's a lot to discuss in there, but I'm going to focus on the part where he talks about "trade imbalances" and tax/spending levels (i.e., the U.S. federal budget deficit):
Recent IMF research found that persistent trade imbalances harm deficit economies and benefit surplus ones by reallocating productivity gains. ...
The IMF acknowledged recently that imbalances are “concentrated and persistent” and driven at least in part by surplus country policies. In its most recent Article IV report, the IMF raised the alarm on the US current account deficit (driven primarily by the trade deficit), noting that the resulting negative net international investment position “raises the risk of an eventual disorderly external rebalancing.”
But, to address this problem, the IMF recommends untenable and outrageous solutions: large-scale tax increases (including a 10 percent federal sales tax) and austerity measures (including deep cuts to popular entitlement programs). ...
Jamieson says the IMF "recommends untenable and outrageous solutions" on taxes and spending. Let's take a look at what they said exactly. On p. 28 of the Article IV report, "Box 5. Potential Tax and Spending Policies to Lower the Federal Debt" provides the following:
A combination of options will be needed on both the revenue and expenditure side of the budget to bring the debt-GDP ratio down over the medium term. These include:
• Scaling back poorly targeted tax expenditures. These include not taxing the value of employer-provided health care, capital gains exemptions for individuals selling their principal residence, and income tax deductibility for mortgage interest and state and local taxes. Removing these tax expenditures would increase progressivity and generate around 1.4 percent of GDP per year in revenues.
• Closing the “carried interest” provision whereby income earned from partners in an investment fund can be treated as capital gains and taxed at a 23.8 percent rate (rather than at the 37 percent top marginal rate).
• Eliminating “step up basis” for capital gains which allows the value of inherited assets to be reset at the date of death so that any capital gains that has accrued during the life of the original owner are effectively never subject to capital gains tax.
• Phasing in a federal consumption tax. Such an increase in indirect taxes would generally be regressive and so would need to be combined with a well-designed social assistance program to cushion the impact on poor households. As an example, a 10 percent, broad-based VAT would yield around 2 percent of GDP in revenues per year.
• Raising the federal excise tax on gasoline and diesel. The federal tax on gasoline and diesel is not subject to indexation and has remained unchanged in nominal terms since 1993 (at 18.4 cents for gasoline and 24.4 cents for diesel). Doubling the tax on both gasoline and diesel would yield around 0.15 percent of GDP per year. A carbon tax could also be considered.
• Raising the corporate tax rate and fully moving to a cashflow tax. If combined, such a change in the corporate tax system could both raise revenue and reduce the marginal disincentive to invest. Each 5 percentage point increase in the corporate income tax rate would yield around 0.3 percent of GDP per year.
• Reducing imbalances in the social security system. Indexing social security benefits to chained CPI would save around 0.1 percent of GDP per year. Subjecting earnings greater than US$250,000 to social security payroll taxes would increase progressivity and yield around 0.4 percent of GDP per year.
• Lowering public healthcare outlays. A range of policies to mitigate the impact of population aging on the federal healthcare deficit have the potential to significantly reduce Medicare outlays and increase the program’s efficiency (see Box 6).
Reasonable people can disagree on these specific suggestions. For instance, I would say that removing the tax exclusion for employer-provided health care is a great idea, and a change that is crucial in order for the U.S. health care system to become something other than the horrible mess it is now; on the other hand, I'm more skeptical of a "10 percent, broad-based VAT." Others might have a different view on each of these.
Regardless of what you might think of each item, though, it's good that the IMF is putting specific proposals out there. It's clear that a change in direction is necessary for U.S. fiscal policy, and it's only going to happen if someone finds a way to get the issue into the political conversation. In domestic politics right now, these problems are mostly being ignored. For almost a decade now, U.S. fiscal policy has involved very high deficit spending, acting as a stimulus to keep the economy growing. You can do that for a while, but at some point you have to adopt a more fiscally responsible set of tax and spending policies.
In the meantime, a side effect of the fiscal irresponsibility is going to be trade deficits that are higher than they otherwise would be. If balanced trade is your goal, then U.S. fiscal policies need to be put in the mix of solutions. Whether the IMF's specific recommendations are appropriate ones will, of course, be the subject of disagreement among people who have always disagreed about these things. Regardless, it's clear that the U.S. needs to reduce its budget deficit, and that one of the effects of doing so will be to lower the trade deficit (although there are many other factors in play here, so it's hard to say with any precision how much of an impact this would have).