The always thoughtful Neil Irwin has a good piece on why tax reform is so damn hard to pull off, citing a concept that’s big here at OTE: path dependency, or “where you end up is significantly a function of where you start out.”
His case study is about leading Republicans’ idea for replacing the corporate tax with a sales-based, border adjusted tax, or the BAT I recently wrote about.
The tax code has been flawed and inefficient for a very long time, precisely because fixing it could be so terribly disruptive. In a nutshell, the corporate tax issue provides an excellent case study of the problem of “path dependency” in public policy.
The United States might well have a better, more efficient tax code today if, starting a century ago, lawmakers had designed it so that businesses were taxed on where their sales and expenses take place, as the Republicans’ plan calls for.
But that is not what happened. Instead, lawmakers took what seemed to be a logical approach: They focused on taxing businesses on their profits. Today, that choice shapes arrangements in every corner of the economy. It affects the values of currencies and financial assets. Every business has devised its structure and organization to maximize its advantage within the existing system.
But Neil makes another point about which I’m not so sure: “A 25 percent rise in the value of the dollar, the most widely used currency on the planet, would have enormous consequences.”
Hmmm. In fact, as shown in the figure below, the real value of the dollar compared to the currencies of countries with which we trade is up almost that much since 2014, and while there have certainly been consequences, they’ve not been enormous and clearly haven’t derailed the expansion (a sudden, large appreciation could be a bigger deal, but I don’t think that’s a realistic reaction to the BAT).
No question, the stronger dollar has dampened inflationary pressures, and has thus influenced Fed policy. Very importantly in today’s political climate, it raises the costs of our exports and lowers the cost of imports. Thus, it is a factor in the trade deficit, which has gotten more negative since the appreciation shown above. That, in turn, has contributed to weak factory employment, down 46,000 over the past year, surely an undesirable and important outcome.
But the recovery has proceeded apace over this period, which itself was one reason that the dollar strengthened. We’re growing faster than other advanced economies and contrary to theirs, our central bank is in interest-rate-raising mode, which also strengthens the dollar. All of which is a problem for team Trump, of course, as per the trade deficit point noted above.
And, of course, who knows how much the dollar would appreciate in reaction to the introduction of the BAT? I’m sure it would appreciate somewhat, but I don’t believe the immaculate/immediate full appreciation story (i.e., I don’t believe the dollar would immediately appreciate enough to fully offset its impact on imports).
But getting back to Neil’s discussion of the BAT: while I’m concerned about various aspects of the proposal—higher costs of imports for low-income households, the too-low rate (see point #4 here), the inconsistent revenue estimates (if the tax reduces the trade deficit, then the revenues it generates fall)—it’s worth recognizing that the dollar goes up and down all the time, and its consequences are not necessarily that disruptive.
What you want to worry about, and I worry about it a lot, is a systematically 0vervalued dollar due to currency interventions by trading partners who want a competitive edge over us.
And with that, let the weekend begin!