America First: The Good And Bad of It, Part 2

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America First: The Good And Bad of It, Part 2
By David Stockman. Posted On Tuesday, January 24th, 2017
There is no route to Draining the Swamp except through a genuine policy of America First. But Donald Trump's courageous and evocative articulation of that phrase in his Inaugural address is not being matched by his choice of advisors and cabinet officers or his own signals about the direction of policy.

As to the latter, for example, at Monday's meeting of manufacturing company CEOs the Donald apparently believed he was issuing a stern warning  against "off-shoring"when he declaimed:

“If you go to another country” and cut thousands of jobs, “we are going to be imposing a very major border tax” on the product that comes back in.

No he isn't!

The Donald's specialty has never been precision with words, and this is a classic case. In the above quote he is meandering somewhere between a "border adjusted tax" and a "border tax". In the vast area in between lies the difference between a clever and perhaps timely approach to corporate tax reform, on the one hand, and out-of-this-world crazy protectionism and statist autarky, on the other.

The Donald's pro-free trade critics have been quick to pounce on the latter interpretation, and appropriately so. As articulated in the above quote from Monday's White House meeting, this kind of subjectively determined and punitive "border tax" sits on a slippery slope not too far from Mussolinii-style corporate fascism.

That is, the President or his agents would apparently ask each and every company among the millions importing goods into America: Are you now or have you ever been a maker of the product in question in the USA?

There would apparently be a 35% or so tax in the event the answer was yes, but mainly there would an endless string of follow-on questions that could end up deep in the supply-chain rabbit hole. The obvious next question, of course, would be how far back in time did you make the product in the USA-----such as within the past year or the past decade or perhaps even the last three decades.

Moreover, at that stage the real pointy-head bureaucrat stuff would start. If the supplier in question both manufactures and also "sources" a line of goods, you would quickly get into the thicket of changing mixes over time of "make" versus "buy" in any given product line; and whether goods obtained through the "buy" option had once been "sourced" with a US based vendor and now were coming from a foreign supplier.

If Trump's jobs police didn't ask and enforce the latter question, of course, the whole thing would be rigged against manufacturers to the benefit of merchant wholesalers. That is, if you had always been a merchant wholesaler and switched your sourcing from a domestic vendor to China---no problem. But if you had been a manufacturer trying to stay in business by switching some of your sourcing from your own plants to China---wham, you'd get a 35% slap upside the head from the back of  theDonald's hand.

Then it would get even more complicated as to any changes in the spectrum of value-added in the case of products which are partially sourced abroad and then completed here such as in "screw-driver" assembly plants or last stage finishing operations.  Under the scheme at hand, presumably a product which was 85% sourced abroad and 15% finished in the USA would pay a 30% penalty, not a 35% penalty.

The again, would the allocation be based on "cost-added" as determined by GAAP accounting or "value-added" as determined by marketplace selling prices?.

This sojourn down the supply chain rabbit hole is not at all theoretical; it goes on in a million venues every day in a vast economy which generates $4 trillion per year of final sales in goods, and is something we experienced close at hand back in the days when we were in the sheet and towel business, for example.

Our company often sourced "greige" goods at ultra-low cost yarn and weaving mills in Brazil or China and then put them through processing steps such as bleaching, dying, sewing, trimming and packaging in US based plants. Often the latter operations weren't necessarily cheaper in US facilities, but were done in South Carolina anyway as part of inventory and SKU (stock-keeping units or product variations) management routines.

That is, 10 SKUs of greige goods might eventually be turned into 200 SKUs of finished goods based on different processing steps, colors, trims and packaging options. The latter were all market-driven based on Wal-Mart's daily replenishment orders-------so the idea was to have short-runs and short-supply chains for the multitude of finished SKU's and long-runs, low-costs and 12,000 mile supply chains for the limited SKUs of greige goods.

Here's the thing. Neither Donald Trump nor an army of GS-15 agents could ever figure out how to apply a 35% "border tax" in the context of this buzzing, blooming nexus of complexity. Indeed, that's why we have the free market.

A border tax, in fact, is a Swamp deepener, and in the worst possible way apart from the obvious economic inefficiency that would result. To wit, it would cause an explosion of lobbying, consulting and lawyering jobs on K-street to determine definitions, classifications, allocations and exemptions. This particular precinct of Big Government would be soon happily squealing like a pen of pigs rolling in the mud.

On the other hand, a "border-adjusted" corporate tax is a fish of a wholly different kettle, and might be a practical, second best alternative to the true solution to the US corporate income tax.

To wit, the right solution is to abolish the corporate income tax entirely. It's a dinosaur in today's global economy where labor, capital and technology are all quickly and cheaply mobile; causes massive allocative inefficiencies and deadweight compliance costs; and even then it generates only a pittance of revenue.

During FY 2016, for example, total collections were just $300 billion or 1.6% of GDP----compared to more than 6% back in the heyday of the 1950s.



The fact is, the statutory rate of 35% is observed wholly in the breech. The average effective yield on corporate income subject to the tax is only about 23%; and an extensive GAO study of major big cap companies with positive taxable income between 2008 and 2013 showed an average rate of only 15%.

The implication is clear. The vast gap between the statutory rate and the effective rates cited above is simply a measure of what the tax lobbies have accomplished over the years to puncture loopholes in the code; and what the tax lawyers, accountants, consultants and investment bankers do day-in-and-day out to minimize tax liabilities-----including many of the economically meritless schemes of the Wall Street deal makers such a corporate inversions.

The truth is, a 2.5% sales tax on domestic consumption of about $12 trillion would generate the same revenue, and in a far more economically benign way. It would essentially be collected by software extractions from cash registers and card swipes.

Billions wasted on compliance and avoidance would be saved. American businesses would make their investment decisions on a level playing field and pharmaceutical companies wouldn't be emigrating to Ireland. Crucially, the ultimate incidence of the taxes necessary to finance government would fall on consumption, which we have way too much of, rather than on income and investment that is already vastly overburdened.

Unfortunately, the rational solution to the obsolete and destructive corporate income tax is opposed by Democrats on populist grounds that it would not be levied based on 'progressive rates", while conservatives have stubbornly opposed a national sales tax or VAT on the grounds that initial  modest rates, like the 2.5% rate cited above, might be raised  substantially---or even drastically---over time.

Needless to say, it is hard to think of any tax under a system of democratic rule that in theory wouldn't be subject to that fate, and so Washington has spent years mired in the swamp of our loophole-ridden corporate tax talking about "reform" and doing the opposite.

So the House GOP's "border-adjusted" tax might be the break-through long needed. It would essentially make the worst distortions and economic waste from the current tax go away by lowering the statutory rate to 20% or even 15%.

At the same time, it would convert the US corporate levy from a global income tax to a territorial tax like those of most other countries, while fully taxing imports and exempting exports, as does every VAT tax collected around the world.

Moreover, the House GOP plan recognizes that Uncle Sam is indeed broke with a $20 trillion national debt that is rising rapidly, and that corporate tax reform must be fiscally neutral. After all, this is not 1981 where Ronald Reagan's giant tax cuts could be accidentally financed with an eruption of Federal borrowing on a balance sheet that was just 30% of GDP, not today's 106%.

The skunk in the woodpile, of course, has just moved into the White House. The Donald appears to be against a "border-adjusted" tax, which might make practical sense, even as he pontificates incessantly for a "border tax".

The latter, of course, could never be approved by Congress; would be shot-down by the courts in a nano-second if done administratively under the trade laws; would cause economic havoc at home and abroad if it every got implemented; and would fill the beltway Swamp with lobbyists and lawyers like never before.

In a word, America First is the right phrase. But the Trump White House has a lot of sorting out today if its true meaning is to be ever realized.

A good place to start would be with the actual cause of the $8 trillion in cumulative trade deficits during the last three decades and the millions of "breadwinner jobs" that have been off-shored as a result.

The culprit is not bad trade deals as Donald Trump keeps insisting and which leads him into absurd policy briar patches like the "border tax".  The real cause is bad money and the place to start is at the Fed, not the USTR and Commerce Department, which the Donald has unfortunately filled with out-and-out protectionists.

We will get to that issue next.