GDP: Taxes, Spending, & Trade

The Gross Domestic Product (GDP) of a country is the value of goods and services produced during a specific time period. The President of the US believes that US GDP is sluggish (a reasonably accurate assessment given 1.6% growth in 2016), and that the way to stimulate the economy (and thus increase GDP) is through a combination of trade reform, reduced government spending, and tax reductions.

There are many factors that can impact GDP growth, that are generally understood as either supply-side (consumption) or demand-side (production) activities. A reduction in taxes (especially for high income earners and corporations) represents a general supply-side approach, in that it is meant to provide more available capital for business owners to invest, thereby increasing production. (Lower taxes overall can provide more available income for consumers, thus increasing consumption.) Lower interest rates are a demand-side mechanism, as it facilitates consumer borrowing and spending. (It can also facilitate business investment, impacting production.)

No one action can guarantee positive GDP. Prices, wages, and consumer confidence, to name a few examples, all work together to impact GDP overall. As alluded to above, and individual activity may impact either the supply or demand aspect depending on how it is employed. Over the last four decades there has been a great deal of emphasis put on supply-side activity, especially with regard to tax policy. The Congressional Research Service in 2012 put out an assessment of tax policy from 1945 to observe the direct correlation between tax rates and GDP.

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Ultimately, the data did not show that any particular tax policy could be said to directly impact GDP on its own (though tax policy impacts many of the other factor that collectively impact economic growth). However, the data directly attribute low tax rates for high earners and corporations to increased wealth inequity. The idea behind lower taxes on the wealthy is that they will have more money available to invest into production capability and employee wages. Unfortunately, that isn’t what happens. Lower top-end tax rates allow the top earners to accumulate more wealth. Accumulated wealth does not stimulate economic activity.

Government investment is a useful mechanism for stimulating GDP in most cases. The government can invest in infrastructure, creating job opportunities and facilitating better logistics capabilities that will positively impact production. Investment in education and training helps improve employee productivity and innovation and helps keep employment rates high. Government investment in any program requires revenue, though. Proposed spending reduction in government programs first targets the very things that are necessary to stimulate economic activity, as well as social programs targeting low-income citizens. As for trade, Tim Worstall argues in a Forbes opinion piece that trade deficits do not negatively impact GDP, given that we consume or use for production that which we import. The trade deficit with Mexico is a good example, as a large part of what we import in used in finished products here in the US. Despite the current trade deficit, NAFTA has resulted in a significant increase in US economic activity (though that has not always translated into a win for the individual worker).

It seems a plausible alternative to what is currently being proposed with respect to trade, taxes, and government spending is to do the exact opposite. Raising tax rates on top earners at the very least has not been demonstrated to stall GDP growth, and there is reason to believe it could have a stimulating supply-side effect. A high tax rate creates a strong disincentive for wealth accumulation. In order to avoid giving a large portion of profit over a certain threshold to the government, businesses could invest in their own infrastructure and provide higher employee wages and/or benefits. (A reinforcing increase to the federal minimum wage could help ensure more money goes to employees, which would increase disposable income and lead to increased consumption.) For those that choose not to reinvest, they will pay more to support government programs that can stimulate demand-side activity. Trade should be viewed in the context of how it will positively impact either consumption or production instead of the narrow view of surplus vs deficit.

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