Supporters of the Republican tax plan claim that business tax cuts, including cutting corporate tax rates and immediate expensing of non-structure investments will increase U.S. business investment and economic growth.  However, this one-sided analysis ignores the impacts of financing the tax cut package by adding $1.5 trillion to federal budget deficits over the next decade.  Past experience has shown deficit-financed tax cuts are associated with higher interest rates, an overvalued U.S. dollar and growing trade deficits.

A recent report from the Council of Economic Advisors claims that tax cuts and the immediate expensing of equipment (non-structural) investments will reduce the user cost of capital (UCC), “increasing firms’ investment, desired capital stock, and potential output.”  In addition, they claim that lowering the UCC will lead “multinational corporations and foreign capital…to invest in the U.S. economy.”  These arguments could have some merit if the plan were revenue neutral, and financed by closing loopholes and through other tax reforms.  However, domestic and foreign businesses are unlikely to invest in the United States if there is inadequate demand for domestically produced goods.  U.S. manufacturing and other traded goods industries (including agricultural products and other traded commodities) will be hard hit by the Republican tax plan, because it is financed through a large increase in the government budget deficit.  Further, real-world evidence indicates that the UCC facing American corporations is already incredibly low yet business investment remains quite sluggish. In short, the UCC is not a current constraint on American investment, so efforts to reduce it further will miss the point in aiming to boost this investment.

Tax cuts that boost post-tax profitability and increase budget deficits will draw in capital from abroad. But while cutting corporate taxes will potentially boost private savings available for investment, the resulting rise in budget deficits will reduce public savings. This rise in budget deficits could well increase the UCC and offset some or all of the investment incentives of the business tax cut). Further, these higher interest rates will attract foreign capital that will partially finance the deficit and hence increase demand for Treasury Securities and other dollar denominated assets. This will, in turn, increase the value of the U.S. dollar.  Increases in the value of the dollar will increase the cost of U.S. exports and reduce the cost of imported goods, resulting in rapidly growing imports and reduced exports, reducing overall demand for domestically produced traded goods.  Manufacturing will be especially hard hit because manufacturing generates about 80% of all traded goods (imports plus exports).

These distortions may be heightened if business tax cuts succeed in attracting more investment in non-traded goods sectors, such as real estate. This happened in the first decade of this century, when foreign capital inflows helped finance the housing boom that eventually led to the crash of financial markets in the United States and other countries.  Increased demand for non-traded assets can exacerbate excess demand for the dollar, leading to even larger dollar appreciation, growing trade deficits and reduced national competitiveness. These cycles can have long-run consequences. The United States has lost over 5 million manufacturing jobs since 1998, and manufacturing employment has not recovered even the jobs lost in the last recession, and these jobs were mostly lost due to growing trade deficits.

We’ve seen this story before and we know how it will end.  The Reagan Tax Cut of 1981 (the Economic Recovery and Tax Act) and the Bush tax cuts of 2001 (the Economic Growth and Tax Relief Reconciliation Act) were both major, deficit-financed tax cuts and both had similar impacts on the economy.  The Reagan tax cut contributed to  the U.S. budget deficit more than doubling from 2.5 percent of GDP in 1981 to 5.6 percent in 1983, and to remain above 4 percent of GDP through 1986. The increased deficit was financed with an inflow of foreign savings, which increased demand for the U.S. dollar.  As a result, the real (price-adjusted) value of the dollar against major currencies rose 27 percent (on average) between 1981 and 1985, and the goods trade deficit increased from 0.6 percent of GDP in 1980 to 2.7 percent in 1985.  Millions of manufacturing jobs were lost, Congress threatened to impose tariffs on major trade partners, and ultimately, Treasury Secretary James Baker negotiated the Plaza Accord to realign the dollar and rebalance trade.

The Bush tax cuts of 2001 also contributed to a massive increase in the government budget deficit, which increased from 0.5 percent of GDP in 2001 to 4.6 percent of GDP in 2003 and 4.1 percent in 2004 (the Bush deficits were magnified also by the recession of 2001 and by the costs of the Iraq war).  Each of these factors also helped sustain and increase a massively over-valued U.S. dollar.  The real value of the dollar began to rise in 1998 (due to the Asian financial crisis), and peaked in February 2002 at a level that was about 13.5 percent higher than before that crisis began.  Although the dollar began to fall thereafter, the goods trade deficit continued to climb due to currency manipulation by China, Japan, and number of other countries, peaking at 6.1 percent of GDP in 2006.

These examples lead to three inescapable conclusions.  First, the Republican plan to cut business taxes will clearly reduce the competitiveness of American manufacturing and other traded goods industries, by driving up the value of the dollar and U.S. trade deficits.  Second, tax cuts will increase, not reduce, budget deficits, as illustrated by prior experience and the resulting upward pressure on interest rates will undo any potential gains from increased private savings following the boost to post-tax profitability.  Finally, the Republican tax plan will, at best, have trivial effects on the rate of growth of output in the United States.  Reducing the competitiveness of American manufacturing and other goods producing industries will reduce, not increase capital investment.  Even in the best possible case, tax cuts simply redistribute growth from traded to non-traded industries, reinforcing the downward pressure on wages as good jobs in manufacturing are destroyed by growing trade deficits, only to be replaced by lower paying jobs in services industries, as has been the case since the end of the great recession.

Finally, contrary to the promises of its supporters, cutting business taxes will not boost American wages.  Rather, the tax plan will simply redistribute income from the bottom up—households in the bottom 40 percent of household would get a tax increase by 2027, while nearly two thirds (or more) of the benefits would go to households in the top one percent.  This Robin Hood-in-reverse plan would be a disaster for most working families, and is nothing more than a payoff to the Trump family and the wealthy individuals and big business that helped put him in office.  Worse yet, it is a slap in the face to the millions of working class voters that put him over the top in the 2016 election.  Members of Congress should stop this bill before it is too late.