The last time Republicans obtained unified control of the federal government, after the 2002 midterms, they immediately set out to pass a large tax cut on dividend and capital gains income. The theory was that by making it more lucrative to invest in American businesses, they would boost business investment in the United States — making our country home to more factories and offices, driving job creation, and pushing up wages.
What happened instead was a weak, highly inegalitarian period of economic growth that was associated with the drift of America’s manufacturing base overseas and an unsustainable debt-financed boom in house building. It ended in tears, Barack Obama served as president for eight years, and then Donald Trump — having earlier toppled the GOP establishment in a tumultuous primary — became president and restored unified GOP control of the federal government for the first time since 2006.
Back in power, the new “populist” GOP is pushing the exact same economic strategy. This time, instead of aiming to slash dividend and capital gains taxes that are levied on people who own shares of stock in big companies, they are directly slashing the corporate income tax paid by those companies. But the effect — by design — is exactly the same. The idea is that by making it more profitable to own American companies, you will juice business investment in the United States.
The reality is that if we do the exact same thing we did when George W. Bush was president, we will likely get the exact same results — an inegalitarian growth pattern, an uncompetitive currency that hurts American manufacturing, and an economy based on rich people lending money to middle-class people so they can buy houses. Since the influx of foreign money that props up the whole machine can’t last forever, we should expect it to end it tears just like it did the last time.
The wonk’s case for Trump’s tax cut
While Republican politicians lie about what their tax bill does, right-of-center wonks are coming together to argue that liberal commentators are ignoring the allegedly strong case on the merits. Not many people would go so far as White House Council of Economic Advisers Chair Kevin Hassett, who promises that a big corporate tax cut will raise wages by $4,000 per year, but plenty are willing to argue that Hassett is at least directionally correct.
Tyler Cowen, the George Mason University economist, argued in Bloomberg that “Republicans have the science on their side” when they argue that a corporate tax cut would boost investment and wages.
After all, writes Harvard professor and New York Times columnist Greg Mankiw, “we live in a world where capital flows from country to country, seeking the highest after-tax return.” Consequently, “when a multinational company is deciding where to put its next capital project, the corporate tax is one factor affecting its decision.”
Mankiw, not coincidentally, was Hassett’s predecessor at CEA when George W. Bush was president. And while the Bush administration didn’t try to make America more investor-friendly by cutting the corporate income tax rate, it did push through major legislation to cut the taxes paid on dividend and capital gains income, which is another way of accomplishing the same thing. The Bush era did not, of course, see a huge increase in American businesses’ competitiveness on the world stage. Instead, Bush-era economic growth, though real, was highly inegalitarian. Manufacturing tended to move overseas to Asia. Domestic asset prices soared, leading to a house-building boom that eventually ended in a crash.
And if you look beyond the bloodless mathematical models, the science says we should expect a repeat of Bush’s economic development playbook to lead to a repeat of Bush’s results.
The mobile kind of capital is money
Mankiw’s account of this perfectly displays a kind of mischief in economic models around the word “capital.” Capital — in the guise of Mankiw’s “capital projects” — plays a key role in production functions. A worker with no capital is just a guy standing on the street corner uselessly. To make things and earn a wage, he needs access to some capital goods — a factory, an office building, a farm, and a bunch of equipment — and the more capital there is to go around, the more he can make and the higher the wage he can earn.
But when Mankiw says that capital “flows from country to country,” he obviously doesn’t mean that actual factories move from Slovakia to Shenzhen to Seattle, relentlessly seeking their highest rate of return.
Capital goods are extremely immobile and tend to stay exactly where they are, whether they are earning a high rate of return or not — Detroit is full of abandoned building because the actual capital goods can’t go to Tennessee or Mexico or wherever the auto jobs may be.
The mobile, flowing kind of capital that roams the globe seeking a high rate of return is money. If America cuts its dividend and capital gains tax rates, then it makes sense for people to move money out of foreign stock markets and into the American stock market. That’s what we did during the Bush administration. It didn’t work to generate widely shared prosperity, but instead of giving up, Republicans have repackaged the same idea as a tax cut on business profits — which amounts to the exact same thing. Again, increasing the after-tax return on owning shares in American companies should make more people want to move money into the American stock market. If that strategy works at all, it should “work” in roughly the way it did for Bush.
Think through what an influx of foreign money means
Conservative wonks like to dangle images of companies taking advantage of the big new influx of funds to build factories and hire workers, because that paints an appealing picture of what the strategy amounts to.
But try to think this through.
If the global investor class decides to shift money into American investment assets, the proximate result will be to bid up the price of the dollar. This will, mechanically, create higher wages for most people in the sense that manufactured goods built in Asia will become cheaper. But it will also lead factories in the United States to close — not open — as made-in-America products become uncompetitive on the global market.
Meanwhile, about half the population owns no stock, while the top 1 percent of the population owns 38 percent of the value of American shares. The next 9 percent of the income distribution owns 44 percent of the stock value. So the share price boost would be a huge win for the top 10 percent (and especially the top 1 percent), while doing nothing at all for the bottom 50 and offering only a minor boost to those who are above average but not rich.
Get ready for housing boom 2.0
With the foreign investment boom simultaneously fueling low interest rates, creating high housing prices, and idling working-class men from manufacturing jobs, the stage will be set for the country to start a residential investment boom.
Coastal areas may be zoned out of the ability to unleash new construction, but Sunbelt suburbs from Las Vegas to Orlando have the right mix of space and lax regulation to grow. Not everyone will move into a brand new home, of course. The same fundamental dynamics will be a spur to the construction of new additions, new decks and patios, or even just refinancing to get the kitchen modernized and upgraded.
The problems with this growth model should have been visible in the mid-aughts, but they definitely should be visible in retrospect.
For starters, even though houses are useful, they’re not productive in the same way that business equipment is. A house won’t create new industries for Americans to work in, or build the great companies of tomorrow that sell things all around the world. Building more houses in the exorbitantly expensive housing markets around the Bay Area, New York, and Boston would increase the dynamism of a few of America’s key economic hubs, but that’s a regulatory issue, not something that an influx of foreign money will fix. If America isn’t going to add houses in the places where the dynamic industries are, what it needs to do is add dynamic industries in the places where the housing supply can grow — simply stuffing more housing into places that lack good-paying jobs doesn’t accomplish very much.
But beyond that, an economic model in which the rich get richer and then the middle class maintains its living standards by borrowing money from the rich can really only end one way. As long as the capital keeps flowing in from abroad, everything’s fine, but when the music stops, you’re due for a banking crisis.
Let’s solve some real problems
A useful sanity check on the theory that what America needs is for more foreign money to be stuffed into our financial markets is to check out MySubscriptionAddiction.com, a site that rounds up the latest and greatest offerings in the very hot startup category of sending people boxes of stuff in the mail.
- The Modern Mystic “is a monthly subscription that delivers you an entire tarot reading … in a box!”
- FabKids will, for the low price of $29.95 per month, send you some boys’ outfits.
- Field to Cup is basically a tea-of-the-month club.
- “CultureFly (the team behind the Pusheen Box, The Nick Box, DC Comics World’s Finest: The Collection) has a new quarterly mystery subscription box for Supernatural fans – Supernatural Box!”
- Foot Cardigan sends you socks in the mail.
You’re never going to have a dynamic market economy without letting a certain number of entrepreneurs with dumb ideas take money from dumb investors to sell dumb products. After all, if it were obvious which the good ideas were, we’d hardly need any new ideas. But the proliferation of lame subscription box startups naturally raises the question of whether we really believe, as a society, that there are tons of great ideas out there that are currently starved of investment funds due to America’s failure to make its tax code sufficiently friendly to business owners.
By contrast, America really does have a bunch of serious problems that would be worth tackling:
- There is an acute scarcity of housing units in most of America’s most prosperous metropolitan areas.
- The process of regional convergence by which poor parts of the country have historically grown faster than rich ones has halted and may even be reversing — with communities built around now-shuttered factories especially lacking in opportunity.
- Opioid overdoses have reached an unprecedented level and show no sign of slowing down.
- Greenhouse gases emitted as a byproduct of fossil fuel consumption are putting the planet on a trajectory for unsustainable levels of warming.
- Despite a fairly high college enrollment rate by international standards, the large share of Americans who don’t finish their degrees has left us with a mediocre ranking in terms of college completion and a lot of people saddled with useless debt loads.
- Exorbitant child care costs are limiting women’s ability to fully participate in the workforce as well as limiting families’ ability to have as many children as they say they’d like.
Reasonable people can and do disagree about exactly what should be done to solve these problems. And that’s as it should be. But it’s plain as day that a big cut in corporate taxes isn’t going to help with any of this, and that starving the federal government of funds by enacting a big corporate tax cut could hurt on several fronts. On the other hand, a big corporate tax cut will definitely generate some windfall profits for already-rich people who already own lots of stock — people like Donald Trump and the Republican Party donor class.
.@RepChrisCollins (R-NY) on tax reform: "My donors are basically saying, 'Get it done or don’t ever call me again.'"— Cristina Marcos (@cimarcos) November 7, 2017
When Republicans explain that this push is a gift to their donors and not the instantiation of a high-minded theory of how to generate long-term economic growth, we should consider believing them.