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The Tax Cut and the Balance of Payments (Wonkish)

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Now that Democrats have taken the House, it seems likely that the Tax Cuts and Jobs Act will turn out to have been the only major piece of legislation enacted under Donald Trump. There might conceivably be an infrastructure bill, but don’t get your hopes up: Trump’s people seem dead set against straightforward public spending, i.e., just building the damn infrastructure, and Democrats probably won’t agree to privatization disguised as public investment.

Now, the TCJA played almost no role in the midterms: Republicans dropped it as a selling point, focusing on fear of brown people instead, while Democrats hammered health care. But now that the election is past, it seems like a good idea to revisit the bill and its effects. What I want to focus on in this piece is the effects on the balance of payments.

Why the balance of payments? Because the theory of the case - the not-necessarily-stupid rationale for the corporate tax cuts at the heart of the bill - depended crucially on claims about what tax cuts would do to international movements of capital. So one important piece of any attempt to assess the results so far involves looking at the balance of payments changes since the lower tax rate went into effect.

And looking at those changes in the balance of payments also offers a good way to debunk some of the fallacies that all too often creep in when we discuss these issues. So let’s dive in, beginning with a recap of how the TCJA’s supporters claimed it would work.

What tax cuts were supposed to do

A tax cut for corporations looks, on its face, like a big giveaway to stockholders, mainly bypassing ordinary families: of stocks held by Americans, 84 percent are held by the wealthiest 10 percent; 35 percent of U.S. stocks are held by foreigners.

The claim by tax cut advocates was, however, that the tax cut would be passed through to workers, because we live in an integrated global capital market. There were multiple reasons not to believe this argument in practice, but it’s still worth working through its implications.

I illustrated this argument with a simple diagram (simple for economists - I told you this was wonkish), reproduced as Figure 1. The figure shows the marginal product of capital - the increment to GDP from an additional unit of capital – as a function of the capital stock. If we provisionally (and wrongly) assume perfect competition, this marginal product will also be the rate of return on investment. Meanwhile, GDP is the area under the curve MPK up to the level of the current capital stock.

What tax-cut advocates argued was that the rate of return in the U.S., net of taxes, is set by global forces. Suppose that there is a global rate of return r*; then the U.S. will have to offer r*/(1-t), where t is the corporate tax rate.

Now imagine cutting t; the figure shows a complete elimination of corporate taxes, but the logic is the same for simply reducing the........

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