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Making America’s Deficits Great Again

Summary:
The new tax legislation pushed through by Donald Trump and congressional Republicans is virtually certain to raise the budget deficit and, in turn, the current-account deficit. Whatever the resemblance to the Reagan-era tax cuts of 1981-1983, it's not morning in America. FRANKFURT – US President Donald Trump and congressional Republican allies have succeeded in passing their big tax legislation. While it lacks many of the desirable attributes of true tax reform, it amounts to a success for Trump, who failed to deliver any other major piece of legislation during the first year of his administration. But what will it mean for Trump’s other major promise, to cut the US trade deficit? The Year Ahead 2018 The

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The new tax legislation pushed through by Donald Trump and congressional Republicans is virtually certain to raise the budget deficit and, in turn, the current-account deficit. Whatever the resemblance to the Reagan-era tax cuts of 1981-1983, it's not morning in America.

FRANKFURT – US President Donald Trump and congressional Republican allies have succeeded in passing their big tax legislation. While it lacks many of the desirable attributes of true tax reform, it amounts to a success for Trump, who failed to deliver any other major piece of legislation during the first year of his administration. But what will it mean for Trump’s other major promise, to cut the US trade deficit?

Simply put, the Republicans’ tax law – which emphasizes big cuts, especially for corporations and the highest-income earners – is virtually certain to widen the budget deficit and, in turn, increase the current-account deficit. Trump’s legislative victory implies the return of the infamous twin deficits that followed George W. Bush’s tax cuts of 2001 and 2003, and Ronald Reagan’s cuts of 1981-1983.

There are different ways to measure the balance of payments, each appropriate for different purposes. The narrowest – and probably the least informative – measure includes only merchandise trade. Yet Trump likes to focus on bilateral merchandise balances, rather than a broader and more useful indicator, such as the overall balance of goods and services.

The current-account balance is broader still, including such other transactions as net investment earnings from abroad, expatriates’ remittances, and foreign aid. It is useful, because it shows whether the United States is spending beyond its means and therefore going into debt to the rest of the world. And, whichever approach an economist takes, the result is clear: Trump’s tax cuts will have a negative effect on the current-account balance.

Start with the simple Keynesian model. A tax cut boosts income and spending. True, Trump’s tax cut focuses heavily on corporate taxes, rather than personal income taxes. But, as Republicans like to point out, corporations are people, too, in the sense that people own and run them.

Most of the corporate windfall that Trump’s tax cut will deliver will be passed through to shareholders in the form of dividends and share buy-backs, and given to managers as higher pay. The recipients will spend some of that additional income on foreign goods, boosting imports and worsening the trade balance.

Jeffrey Frankel
Jeffrey Frankel, a professor at Harvard University's Kennedy School of Government, previously served as a member of President Bill Clinton’s Council of Economic Advisers. He directs the Program in International Finance and Macroeconomics at the US National Bureau of Economic Research, where he is a member of the Business Cycle Dating Committee, the official US arbiter of recession and recovery.

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