Bastiat's Bastions

One of my students raised an interesting point when we discussed international trade and comparative advantage.  It seemed that all he had heard was that the U.S. no longer made much  anymore.  Now his point was more that we consume beyond what we produce, borrowing too much to pay for the trade deficit.  Still, many have the view that since manufacturing employment in the U.S. continues to decline (it peaked in 1979), that the U.S. is no longer making much stuff to sell.  Of course, part of what has been going on is that the U.S. has been increasing its services production.  Below is a link to a CBS news video along with links to a few articles on what has been going on with our production and trade in both manufacturing and in services.

First, is the rather misleading video of the CBS report by John Blackstone that aired 2/16/2010 on manufacturing in the U.S.  Note that the declines mentioned are measured in jobs rather than in output.

Now here is an article by Dan Ikenson of the Cato Institute that appeared in National Review Online in August, 2009 where he busts the myth that “We don’t [make things] any more — at least, not like we used to.” 

Along the same lines is a little longer is another article by Ikenson, “Thriving in a Global Economy: The Truth about U.S. Manufacturing and Trade,”  from 2007.

In an email (via a list I am on) from Ikenson I got Feb. 17^th, Ikenson writes:

The manufacturing jobs number (which, by the way, peaked in 1979 and has been on the same downward-sloping trajectory since then) masquerades as a barometer for the health of manufacturing, which has been setting all kinds of records with respect to output, value-added, revenues, profits, return-on-investment year after year (with the exception of the recent recession, which affected all sectors of the economy similarly). 

American manufacturing remains the world’s most prolific manufacturing sector accounting for 20-24 percent of global value-added; China accounts for about half that.  People ask: How can that be when most shelves in retail stores are loaded with products made in China, and ”Made in USA” labels are nowhere to be found?  Part of the explanation is that products labeled made in China are only 35-50%, on average, Chinese value-added.  (Apple iPods, which each register in our trade stats as a $150 import from China, contains about $4 of Chinese value-added–that’s only 3%!)  “Made in China” often means “snapped together in China” from components made in Japan, Taiwan, Singapore, Korea, and the United States.  Another part of the explanation for the dearth of “Made in USA” products on retail shelves is that U.S. manufacturing doesn’t make a lot of products sold on retail shelves.  Pharmaceuticals, chemicals, sophisticated componentry, airplane parts, and technical textiles aren’t sold through retailers, and those are some of the high-value products made in America.

Michael McKee writes this article at Bloomberg.com (Bloomberg News) from November, 2009, also busting the myth of U.S. manufacturing declines.

Finally, take a look at this February 17, 2010 op-ed article from the New York Times by W. Michael Cox , director of the Center for Global Markets and Freedom at Southern Methodist University’s Cox School of Business.  Cox writes here on the huge and growing size of U.S. production and exports of services.  I should point out that Dr. Cox is the former chief economist of the Dallas Federal Reserve, and even though I never had a class with Dr. Cox (he arrived my second year of graduate school), I still learned a good bit from him in our twice-a-week seminars at Virginia Tech.

 -MC

(A note to my students looking to get comment points–you will need to show that you looked at the video and have read the articles linked and cited above, or have done other reading on the subject–and link to your sources.)

What got my attention this week was something I heard this past Sunday on Fareed Zakaria’s Global Public Square (GPS) program on CNN.  Zakaria states point blank, that the Bush tax cuts are the single largest part of the deficit.

Notice that Mr. Zakaria thinks he has Greenspan and Paulson in a “gotcha moment,” claiming that they fail to live up to the ”courage of their convictions”  by not supporting immediate repeal of the Bush Tax Cuts.  The problem is that Zakaria is a poor listener.  We face two problems, the recession, which is short term and acute, and the deficit which is long term and chronic.  Notice that Paulson says that the deficit is a long-term problem.  Zakaria is missing a vital point in this discussion.  Reducing deficits, either by raising taxes or cutting spending, during downturns are widely thought to exacerbate recessions.  Paulson and Greenspan both suggest that now, because of our current recession, is not the time to be raising taxes, but they never rule out raising them at some time in the future.

Zakaria later points listeners to a Feb. 4, 2010 article in Time by Jeffrey Sachs, a leading economist at Columbia University, whose work on something called the “natural resource curse” has captured my recent research attention.

The current budget deficit runs about 10% of our national GDP (US  tax receipts are currently at 15% of GDP while spending is at 25%).  Sachs writes in his article that closing up the Bush tax cuts on the rich would only amount to .4% of GDP, which means that the Bush tax cuts account for only 4% of the deficit.  Sachs states: “even with rollbacks of tax cuts for the rich, the fiscal gap will remain enormous.  The Bush cuts in rates hardly account for the biggest part of the current deficit, as Zakaria claims.  Zakaria is not only a poor listener, he is also a poor reader.

Take a look at this picture of Federal Spending and Receipts in millions of dollars:

Here are those same figures but as percentages of GDP:

I should point out that there were actually two Bush Tax Cuts, one enacted in  2001 after 9/11 and the other in 2003.

Note that tax revenues rose faster after the 2nd Bush tax cuts than they did in the Clinton era, with the tax revenue growth coming to an end in 2007 at the beginning of the recession.

More importantly, notice that starting in 2001, public spending as a percent of GDP started to grow again after shrinking, as it had over the Clinton era.  While we should avoid post hoc thinking, we should also note that while the  tax cuts may have led to revenue declines, there were also large increases in government spending that started at the beginning of the Bush era.  The Bush spending programs included a generous pharmaceuticals program for the elderly, an increase in Homeland Security spending, an expensive war in Iraq in 2003 and allowing Republicans in Congress to spend heavily in their districts to increase their reelection chances.

It is the growth of entitlement spending that is at the heart of our future deficit problem, and in the very near future, growth in entitlement spending, from Social Security to Medicaid to Medicare, will be the drivers in our deficits.  Driving these spending figures are an aging population and rising health care prices.  One of the biggest reasons for the rising health care prices is that we have an aging population, boosting the demand for health care goods and services.  Increasing entitlements, through the health care bills that have gotten approval in the House and the Senate are destined to push projected deficits even higher.

A more realistic, as well as more pessimistic, view of the growing defict is reported in this ABC article.  The article reports the findings of the Peterson-Pew Commission on Budget Reform.  One of the commission’s publications is the testimony of Alice Rivlin.  Rivlin, an economist who was appointed by Johnson, Carter and Clinton to various government posts, recently testified before the Senate Budget Committee.  In her testimony, she states “In the next decade and beyond, federal spending, driven by the impact of an aging population and rising health care costs on Medicare, Medicaid, and Social Security, will rise substantially faster than the whole economy can grow–faster than the GDP.  Revenues, at any likely set of tax rates, will grow only slightly faster than the GDP.  The gap between spending and revenues will keep widening.” Obviously, repealing the Bush Tax Cuts, as Zakaria suggests, will do little if “revenues, at any likely set of tax rates,” will grow more slowly than the promised spending from Medicare, Medicaid, and Social Security.

Recently, my daughter and her roommate drove from Natchitoches, LA to Monroe, LA and followed her roommate’s global positioning device.   The car’s GPS routed them through Shreveport, doubling the usual time through Winnfield and Ruston.

As bad as the advice my daughter and her roommate got from the auto GPS, it did get her to her destination.  Zakaria’s suggestion that repealing the Bush tax cuts, or allowing them to expire, would put us much closer to erasing the deficit is just seriously misleading.   Zakaria’s GPS does not even set us on the right path.  Perhaps if Zakaria would listen more carefully and read the articles he suggests to his listeners, he might be worth listening to.

And this just in, President Obama has created a bi-partisan commission to come up with ways to deal with the deficit crisis.  From what I understand, the commission’s proposals would come before Congress to be voted on, yes or no, without amendments.  Unlike Zakaria’s suggestion of dealing with the Bush Tax Cuts (which should be on the commission’s table), President Obama has put us on course to effectively dealing with the long-term deficit problem, looking at both the spending and the revenue side of the deficit problem.

-MC

Firms are very clever in their ability to extract willingness to pay information from customers. For example, brokerage firms likely use price discrimination to maximize the number of orders on which they receive commission. They do so by allowing clients to place “limit orders.” A limit order asks the broker to buy so many shares of a stock, on behalf of the client, at no more than a particular price. Limit orders are convenient in that they allow the client to opt out of an order should a share price rise dramatically before a buy order is executed. This is especially useful if the client possesses a limited amount of tradable funds. However, limit orders can hurt the client in that they ask him to express his spot willingness to pay for shares of the stock. The broker can (and likely does) use this information to maximize the number of commissioned trades he can execute.

For example, suppose that a stock begins the day at a price of $1.01 and rises steadily throughout the day to a closing price of $1.10. A brokerage firm has 10 limit orders, each of which asks to buy one share of the stock. One order places an upper-limit of $1.01 on the purchase price. Another order places an upper-limit of $1.02. This pattern continues such that there is one order at each of the following limits: $1.01, $1.02, $1.03,…, $1.10. Suppose that trading for this stock opens at $1.01 a share, and the brokerage has an opportunity to fill one of the orders at this price (Assume that the market for this particular stock is thin or low-volume in nature.). Which order will the broker fill first? Will he choose randomly? Will he fill the first order placed? A price-discriminating broker who wishes to fill the most commissioned orders will begin with the $1.01 limit order. Such a broker will do so because he may be able to fill any of the other orders at a later time should the share price subsequently rise. However, he does not have this luxury with respect to the $1.01 limit order. If he does not execute this order in the first round of trading and the share price then goes up, the order will go unfilled. Thus, one might pay a hidden cost for the convenience of a limit order. Market orders, on the other hand, are less convenient but betray no information to the broker as to one’s spot willingness to pay for a particular share of stock.

-SS

Once again, the idea of introducing a Value-Added Tax (VAT, better termed the “Stealth Tax”) to curb our mushrooming deficits is being discussed. This time, in a Feb. 4, 2010 article in Time magazine, Columbia University economist Jeffrey Sachs suggests the use of a new tax in America, the VAT, stating “Both sides could agree, for example, on a value-added tax (VAT) – a sort of national sales tax – combined with closing loopholes and reducing some marginal tax rates, including the corporate tax rate….”

Suggesting that we use a VAT instead of a straight-up sales tax to finance anything in this country, even a reduction in the corporate income tax, signifies either a lack of understanding of basic public finance or a willingness for the federal government to increase taxes on American buyers in ways unperceived by most voters.  While a VAT would be more visible than running deficits, which is another form of unperceived taxation, a regular sales tax would be far more visible by tax payers and works better in other respects, as well.

Sachs is right that a national VAT is sort of a national sales tax. With the VAT, instead of charging a flat rate on every dollar of retail sales, that same rate is collected from producers on the difference between the cost of the goods that they sell and their sales revenues, that is, on the value that they add to goods at each stage of production, from raw materials producer to manufacturer to wholesaler to retailer. Take the case of a loaf of bread that sells for a dollar. In the process of making the bread, a wheat farmer sells wheat to a mill which sells flour to a bakery which sells bread to a store which sells it to the final customer. The wheat that went into the flour that went into a loaf of bread sold for a quarter, while that much flour sold for a half dollar while the baker sold the bread to the retailer for 75 cents. Each producer adds a quarter at each of the four stages of production. If each producer is charged a 10 percent VAT, each of the four pays a tax of 2 1/2 cents, which adds 10 cents to the cost of the bread. The price of the bread ends up going up by 10 cents, the same amount as it would if there were just a national sales tax of 10 percent. Who ends up paying for this tax? It is the same person who ends up paying the sales tax, mostly the consumer.

This does not mean that there is no difference between these sales taxes and the VAT. Since most areas of the country already have some sort of sales tax, a national sales tax would cost little extra to collect. With a VAT, we would have to add a huge bureaucracy of accountants to check the cost of goods sold and the sales at each stage of production. This is a very costly tax to collect. With a sales tax, however, we could, in most states, piggyback collection and enforcement efforts on state and local government efforts.

Another difference is that the burden of a sales tax on the poor can be eased by putting exemptions on certain classes of goods, such as groceries, utilities or medicine, because the poor spend a larger portion of their income on these items than wealthier citizens. With a VAT, producer groups can be excluded, not consumer groups. Instead of easing the burden on certain consumers by exempting certain items such as groceries and medications from the sales tax, the VAT can only exempt certain producers.  This not only makes it difficult for the tax to be eased on the poor, but also makes it more likely that many producer groups will be lobbying in Washington to get their group excluded from the tax. Special interests do not lobby as much for exemptions from sales taxes because it is harder for consumer groups to organize than it is for producer groups. For Sachs, who rightly complains of the influence of special interests in Washington, to give special interests a greater incentive to lobby in Washington means that he does not understand the political incentives posed by certain forms of taxation.

A national VAT differs from a national sales tax in another important way. With a sales tax we see what we pay in these taxes at the cash register. The consumer never sees the bill for a Value-Added Tax, though the consumer ends up paying for the tax since it is mostly passed forward to the buyer. The lack of visibility of the VAT has prompted some critics of this tax, including me, to call it the Stealth Tax, because it hits the taxpayer/voter before she ever sees it coming. If there is a tax increase to pay for some new spending program, the tax increase is passed on as a price increase, and the buyer tends to blame the seller instead of the government.  But when the taxpayer/voter sees the bill for big government, she starts to question whether the spending is necessary. But when we don’t perceive the costs, we seldom question the value of the spending program.

The problem of the lack of visibility of a tax was first pointed out in 1903 by the Italian economist, Amilcare Puviani (as we see in this Richard Wagner paper), and then popularized among English-speaking economists by one of my professors, Jim Buchanan, a problem that has been called “fiscal illusion.” As voters, we are more likely to ask for new spending programs if we never notice how much it costs.   Importantly, Buchanan and others have noted that tax cuts and deficits fail to “starve the spending beast” of government, as many conservatives have proposed to deal with government spending, and instead reduce the visibility of the cost of spending to voters. Voters, then, become more supportive of almost every new spending program that comes along.  If the problem we are tackling with the VAT is the deficit, a very visible national sales tax makes a better weapon against the deficit than the stealthy VAT.

Sachs is quick to remind us that the VAT is widely used in Europe. This is true. And the Europeans have tackled the regressivity of the VAT buy introducing many spending programs to help the poor.  If we are facing a deficit problem, it would seem that additional programs to help alleviate tax regressivity unnecessarily add to the deficit by increasing spending on uncontrollable entitlements.

We should also note that the Europeans arrived at their VAT by their own peculiar history. Their VAT evolved from their former business tax, a tax on gross receipts at each stage of production. In our bread example, a 10 percent tax would collect 2 1/2 cents from the farmer, a little more than a nickel from the miller, about 8 cents from the baker and about eleven cents from the retailer, adding up to more than 21 cents. The Europeans quickly found that businesses could avoid the tax by combining the various stages of production into one business which would lower their taxes considerably, giving vertically integrated firms an advantage over those there are not.  It should also be pointed out that the Europeans already had a system in place to tax at each stage of business sales rather than a retail sales tax bureaurocracy.

So, if we are to go down the road of a new national tax on spending, we should note that a true national sales tax is superior to a VAT at every step, from being more visible and more of a deterrent to federal spending sprees, to being better suited to being shaped to help protect the poor from tax regressivity, to being less prone to being shaped to the liking of special interests, to being cheaper to administer.

-MC

(Note: I have written more than once about the Value-added tax, or VAT, and have repeated some of my own words from past articles, especially see “Vat for financing health care proposals still a bad idea.”)