Tom Brenner / The New York Times
Saturday, Nov. 18, 2017 | 2 a.m.
WASHINGTON — President Donald Trump has promised to cut federal taxes and reduce the nation’s trade deficit with the rest of world — two economic priorities that are in direct conflict with each other.
A wide range of experts agree that cutting taxes is likely to increase the trade deficit, which measures the difference between what the United States imports from other countries, like televisions and fruit, and what it exports, like cars and meat.
In fact, a larger trade deficit is not a byproduct of the tax plan — it is the heart of the plan. The administration has said its $1.5 trillion tax cut will not balloon the federal budget deficit because the plan will generate enough economic growth to essentially pay for itself. The most optimistic projections of the likely economic benefits of the tax cuts are driven by increased trade deficits.
“I do expect a major trade deficit, absolutely, as part of this,” said Laurence J. Kotlikoff, a professor of economics at Boston University who supports the proposed tax cuts and whose analysis of the economic benefits has been cited by the White House. “If this tax plan works, it works because the U.S. becomes more open to trade.”
The connection between tax cuts and trade deficits is not controversial. The mechanics are straightforward: Republicans are proposing to reduce federal revenue through a $1.5 trillion tax cut without a commensurate reduction in federal spending. To pay for the tax cuts, the government will need to borrow more dollars, some of which will come from foreign investors. Foreigners will get those dollars by selling more goods and services to Americans, which will widen the trade gap.
“There may not be much that macroeconomists can predict with accuracy, but a large tax cut will lead to a budget deficit, which will lead to a trade deficit,” said Jeffrey Frankel, a professor of economics at Harvard.
One widely cited economic simulation, the Penn Wharton Budget Model, projects that the tax plan approved by the House on Thursday would increase the trade deficit by about $800 billion over 10 years. That would increase the annual trade deficit about 16 percent from its 2016 total of $502 billion.
Trump has repeatedly promised to reduce the trade deficit, which he again described as “unacceptable” in a speech Wednesday after a trip to Asia.
“We are going to start whittling that down, and as fast as possible,” he said.
The inconsistency does not trouble the many economists and Republicans who do not share Trump’s overarching view on the downsides of trade. From their perspective, the point of the tax plan is to increase investment in the United States, and there is no reason to shun foreign dollars.
Gavin Ekins, a research economist at the conservative Tax Foundation, said Trump’s objectives were still aligned in the longer term because increased investment would expand the nation’s economic output over time, which could narrow the trade deficit.
“We think that of course you’re going to have to go through a period in which you have higher trade deficits,” Ekins said. “But expanding capital investment means we’ll produce more than we used to, and that is going to increase the exports that we have.”
Wilbur Ross, the commerce secretary, offered a similar reconciliation of the administration’s conflicting objectives this week.
“Job creation is the real purpose of reducing the trade deficit,” Ross said during an interview at the Wall Street Journal CEO Council. “The way we mainly wish to reduce the trade deficit is by increasing our exports as opposed to constricting imports.”
Another option would be to fund government borrowing through the Federal Reserve, which could create money to buy federal debt, as it did on a large scale in the years after the 2008 financial crisis. But the Fed has embarked on a plan to reduce its holdings of Treasury bonds and mortgage-backed securities. That leaves domestic and foreign investors as the potential buyers of the debt the United States will need to sell to pay for its tax cut.
While economists agree that the tax cuts will widen the trade deficit, they part company on how much of the money that the federal government needs will come from foreigners.
The answer will help to determine how much of a lift the cuts give the economy. When the government borrows from Americans, it is soaking up money that could have been used by the private sector. When it borrows from foreigners, more money is available for other uses.
“To get bigger growth effects, you need more foreign capital coming in,” said Kent Smetters, a professor of economics at the University of Pennsylvania and the faculty director of the Penn Wharton Budget Model. “That is the irony — tax cuts have the biggest effects if you’re assuming that trade actually increases over time.”
Foreigners hold about 40 percent of federal debt, and Smetters projects that they will continue to do so. His model projects that the government would need to issue $2 trillion in additional debt for the tax cuts over the next decade, and that foreigners would buy $800 billion.
That would add $80 billion to the annual trade deficit — significantly more than, for example, the United States' $56 billion trade deficit with Mexico last year.
The Trump administration regards the trade deficit as a drain on the economy. Trump has said other nations are stealing from the United States by selling goods and services to Americans without spending just as much money on U.S. goods and services.
Most economists, by contrast, see the trade deficit as a crude measuring stick that says little about the health of the domestic economy. This includes economists who think trade has imposed significant costs. The disruptions caused by trade are determined by the volume, not the balance. The workers at an Ohio factory that moves to Mexico do not benefit directly if a German company opens a comparable factory in Tennessee.
But the biggest proponents of the tax cuts — excepting the Trump administration — also tend to be cheerleaders for increasing foreign trade.
And it is their projections that the Trump administration has embraced in arguing that the tax plan moving through Congress will generate enough economic growth to let the government collect the same revenue at lower tax rates. Kotlikoff, for example, projects the tax cuts will not increase the federal debt over the long term — because of foreign investment.
Kotlikoff regards this as a good thing. He said Americans were not saving enough money, so the best way to fund the investments necessary to increase economic growth was to import the money, expanding the nation’s trade deficit.
“Does that bother me?” he asked rhetorically. “Absolutely not.”
He said the administration appeared not to understand the mechanics of his analysis, or similar analyses — or the workings of its own plan.
“This is a White House that does not know economics,” he said.