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Tax Cuts, Growth, and Leprechauns

Summary:
Yesterday the Tax Policy Center released its macroeconomic analysis of the House tax cut bill. TPC is not impressed: their model says that GDP would be only 0.3 percent higher than baseline in 2027, and that revenue effects of this growth would make only a tiny dent in the deficit. But Brad DeLong reminds me of a point I and others have been making: focusing on GDP is itself misleading, because we’re a financially open economy with a lot of foreign ownership already, and a large part of the alleged benefit of corporate tax cuts is that they will supposedly draw in lots of foreign investment. As a result, we should expect a significant fraction of the benefits of corporate tax cuts to go to foreigners, not domestic residents; income of domestic residents should rise less than

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Yesterday the Tax Policy Center released its macroeconomic analysis of the House tax cut bill. TPC is not impressed: their model says that GDP would be only 0.3 percent higher than baseline in 2027, and that revenue effects of this growth would make only a tiny dent in the deficit.

But Brad DeLong reminds me of a point I and others have been making: focusing on GDP is itself misleading, because we’re a financially open economy with a lot of foreign ownership already, and a large part of the alleged benefit of corporate tax cuts is that they will supposedly draw in lots of foreign investment. As a result, we should expect a significant fraction of the benefits of corporate tax cuts to go to foreigners, not domestic residents; income of domestic residents should rise less than GDP.

So I’ve been trying a back-of-the-envelope estimate of the difference leprechaun economics (so named because Ireland is the ultimate example of a country where national income is much less than GDP, because of foreign corporations) makes to the analysis.

Start with the direct effects of a corporate tax cut. The JCT puts the revenue loss at $171 billion in 2027. Assume, as is roughly the consensus, that 1/3 of this accrues to workers, but two-thirds to capital. Steve Rosenthal says that about 35 percent of this gain, in turn, accrues to foreign investors. So right there we have about $40 billion in additional investment income paid to foreigners.

Then there are the effects of the trade deficit. I can’t figure out TPC’s estimate there, but typical numbers from other modelers say that we’re looking at around $80 billion a year, or $800 billion in increased net foreign liabilities. BEA numbers say that foreign investors in the US earn on average about 2%, U.S. investors abroad around 3%. So this suggests an average return of maybe 2.5%? My guess is that this is low, because the changes would be focused on direct investment, which earns higher returns. But let’s go with it: in that case we’re talking about another $20 billion in investment income paid to foreigners.

Put it together, and for 2027 I get $60 billion in reduced GNI relative to GDP. Potential GDP is supposed to be about $28 trillion by then, so we’re talking a bit over 0.2% of GDP.

Remember, TPC estimates the extra growth in GDP at 0.3%. So according to the back of my envelope, leprechaun economics — extra payments to foreigners — basically wipe out all of that growth.

And let me say that I am not entirely clear, given this result, why there should be any dynamic revenue gains. Given how scrupulous TPC normally is, they probably have an answer. But as far as I can see there’s no obvious reason to believe that dynamic scoring helps the tax cut case at all, not even a little bit.

I’m sure that people can improve on my back-of-the-envelope here. But for now, it looks to me as if, properly counted, these tax cuts would do nothing for growth.

Paul Krugman
Paul Robin Krugman (born February 28, 1953) is an American economist, Distinguished Professor of Economics at the Graduate Center of the City University of New York, and an op-ed columnist for The New York Times. In 2008, Krugman won the Nobel Memorial Prize in Economic Sciences for his contributions to New Trade Theory and New Economic Geography.

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