SLOW GROWTH AND MAKING AMERICA GREAT

AGAIN
SUMMARY

Call it stagnation, stagflation, or ordinary performance there are reasons

economic growth has moderated including demographics, declining
productivity, low savings, low investment, erosion of the middle class,
devastating recessions, automation leading to slow job growth, and high
debt levels.
The need to reform international tax codes is recognized by the OECD and
WTO and is an evolving process. Corporate tax reform will be beneficial to
adjust for the U.S. tax system being based on income and the most of
the rest of the world relying more on consumption (VAT) taxes. Tax reform
may increase revenues by reducing the incentives to seek tax havens.
High social entitlements and benefits enacted during periods of high
growth cannot be supported during with slow growth.
Reducing top tax rates and capital gains taxes will continue to benefit the
wealthy more than the middle class, but will increase investment in the
U.S. and reduce tax evasion.
The trade imbalance is largely the result of low savings and capital flows
and their impact on exchange rates. Fair trade is beneficial to the U.S.
economy and to U.S. firms.
The current reforms and stimulus are likely to provide a temporary boost
to the economy, but long term growth of 4% is highly unlikely.

INTRODUCTION

This article looks at two topics covered on the White House website: improving
employment and economic growth through tax reform and renegotiating trade. This
article first looks at the impact of high valuations on future returns, why economic
growth has slowed over the past several decades, that entitlements set in motion
during high growth periods are unsustainable during slow growth, the direction and
impact of debt, why companies are moving abroad, the impact of tax reform and
fiscal stimulus, the importance of trade, and likely reforms. The topics are complex
so I draw heavily on research from many sources. Hopefully, I got most of this right
and apologize for any errors.
The base case for the next decade is provided by the Congressional Budget Office
(CBO) Outlook. [I]n CBOs view, there is a two-thirds chance that the average
growth rate of real GDP will be between 0.7 percent and 3.2 percent over the next
five years. The CBO projects that the Federal Funds rate will rise to 1.8 percent by
the end of 2018. Interest rates on the 10 year treasury are estimated to rise to 3.4
percent by the end of 2020. The budget deficit will increase to $1T (trillion) by 2024.
Federal debt held by the public will increase by $9T. The increase is due mostly to
Social Security and Medicare and higher interest rates. The CBO sees that the rising
debt will cause increased spending on interest payments, reduced total saving in
the economy, fiscal responses will be less effective and increases the risk of a fiscal
crisis. (Source: An Update to the Budget and Economic Outlook: 2016 to 2016 by
the Congressional Budget Office, 2016)
The International Monetary Fund has raised the U.S. economic growth forecast by a
half a percent to 2.3% this year and 2.5% next year based on expected tax cuts and
increase infrastructure spending. Both the IMF and World Bank warn that restrictive
trade policies may negatively impact global growth. (Source: A Shifting Global
Economic Landscape: Update to the World Economic Outlook by Maurice Obstfeld,
The World Post, 2017).

DEFINITIONS
Current Account: consists of the balance of trade, net primary income or factor
income (earnings on foreign investments minus payments made to foreign
investors) and net cash transfers that have taken place over a period of time.
Capital Account: (also known as the financial account) reflects net change in
ownership of national assets.
Source: Wikipedia
The relationship is the Current Account = - Financial Account = Savings
Investment
Balance of Payments: The Current and Capital Accounts make up the balance of
payments. The sum of the balance of payments should be zero.
Net International Investment Position (NIIP): a nations stock of foreign assets
minus its foreign liabilities and the value of overseas assets owned by a nation
minus the value of domestic assets owned by foreigners. NIIP includes overseas
assets and liabilities held by a nations government, the private sector and its
citizens. A negative NIIP figure indicates that a nations foreign liabilities exceed its
foreign assets, while a positive NIIP figure indicates that its foreign assets exceed its
liabilities. These may be the result of claims on assets instead of loans.
Source: Investopedia
Gross Domestic Product = Consumption + Business Investment + Government
Spending + Net Exports

OECD: The mission of the Organisation for Economic Co-operation and

Development (OECD) is to promote policies that will improve the economic and
social well-being of people around the world. It was established in 1948 to run the
US-financed Marshall Plan for reconstruction of a continent ravaged by war.

WHERE WE ARE TODAY

The next chart shows that Quantitative Easing (QE, green) increased reserves
balances held at the Federal Reserve. Interest rates on government bonds in the
U.S. paid less than in the Eurozone (Spread between U.S. and Euro Area, blue) which
put downward pressure on the exchange rate (red) for the dollar. QE has been
unwinding, interest rates paid on government bonds is now higher in the U.S.
relative to the Euro Area and the exchange rate has been rising for the past couple
of years. The higher exchange rate makes U.S. exports more expensive.

My Investment Model shows signs of improvement since mid-2016. The Fed targets
are in range for unemployment (below 5%) and inflation has risen steady (now
above 2%). The economy is growing slow and steady with the 2016 Q4 first
estimate of real GDP at 1.9% YOY. The NY Fed forecasts 2017 Q1 growth to be 2.7%.
I built my Investment Model to vary my allocation based on the business cycle. It
uses 29 main indicators consisting of nearly 100 sub indicators. My minimum stock
allocation is set to 20% and the indicator has increased over the past six months
from 20% to 45% as the economy shows signs of improvement. I remain cautious
until the euphoria of the Trump win fades.
SECULAR MARKETS, VALUATIONS AND INTEREST RATES

Ed Easterling at Crestmont Research has done an excellent job describing Secular

Stock Market Cycles. In his recent update, he says that all measures of price to
earnings of the current cyclical bull market are well above their averages even
given low inflation and interest rates and the stock market is significantly above
average. While the economy can grow, valuations can fall so that there can be
decades of low returns in stock markets. (For charts of secular markets see Stock-
Secular-PE, Watch Unexpected Returns: A Course of Insights by Ed Easterling for
a free course in Secular Markets.)
In my opinion, low interest rates do not justify the high valuations for stocks. The
chart below shows that during the past 70 years, 10 year Treasuries have been at 2
to 3% only in the 1950s and the past five or so years. The current Market
Capitalization/GDP ratio of 1.6 now compares to less than 1.0 in the 1950s. As
interest rates rise to 4%, Market Valuations are likely to fall to the 0.8 to 1.4 range.
 Market Valuation and 10 Year Treasury Rates

Vanguards 2017 Global Economic and Investment Outlook states their belief that
without the driving force of demographics and consumer debt growth that 2%
GDP reflects current long term growth prospects. Vanguard's outlook for global
stocks and bonds remains the most guarded in ten years, given fairly high
equity valuations and the low-interest-rate environment. We continue to believe
that global bond yields will not increase materially from year-end 2016 levels.
Vanguard estimates the risk of Recession or Stagflation in the short term to be 30%
with a 35% probability of a cyclical acceleration. (Source: Vanguards 2017 Global
Economic and Investment Outlook)
Gary Shilling recently said on Bloomberg television that the Federal Reserve has
been overly optimistic about economic growth and raising interest rates. He expects
that there will be massive stimulus but that it will take a couple years for it to be
approved, implemented and have an effect. (Listen to Gary Shilling: Fed Will Fall
Short of Rate Targets on Bloomberg)

SECULAR STAGNATION AND ORDINARY PERFORMANCE

I put the next chart together to look at historical growth trends in productivity and
the real economy by decade. Both have been declining post-WWII. Tax reform, trade
policy and stimulus will not fully reverse this 70 year secular trend. There will be
short term cyclical spurts.
The economies of the world are slowing along with the U.S. as shown below. S&P
500 companies get about 45% of their revenue from outside of the US. Slow growth
outside of the U.S. is negative for the U.S. over the long term.

Source: World Bank, Gross Domestic Product for World [NYGDPMKTPCDWLD], retrieved from FRED, Federal Reserve

Bank of St. Louis; U.S. Bureau of Economic Analysis, Gross Domestic Product [GDPA]; chart shows

[NYGDPMKTPCDWLD] - [GDPA]
From 1986 through 1999, while world GDP growth was slowing in the low single
digits, real world foreign direct investment grew nearly 18%. About 90% of U.S.
exports and imports flow through a U.S. multinational corporation with nearly half of
the U.S. trade occurring between affiliates of the same multinational corporation.
(Source: Foreign Direct Investment Behavior of Multinational Corporations by
Bruce A. Blonigen, NBER, 2006)
Marc Levinsons Extraordinary Time: The End of the Postwar Boom and the Return
of the Ordinary Economy describes the 1960s and 1970s as characterized by post
WWII boom, high regulation, high taxes, ending of the Bretton Woods Agreement,
switching to floating exchange rates, OPEC oil embargo, high inflation, and low debt
levels. One term he applied during that time period is of the Welfare State where
high taxes needed to support social programs enacted in better times were
assumed to last. He makes the point that during certain time periods, factors such
as technology or education have improved productivity, but these circumstances
are not due to temporary stimulus. These booms are largely the result of the private
sector which take many years for new technologies to impact productivity and
cannot easily be influenced long-term by governments. Mr. Levinson says ordinary
performance more accurately describes our current slow growth than secular
stagnation. (To listen to a Financial Sense podcast with Marc Levinson click here:
Marc Levinson on An Extraordinary Time: The End of the Postwar Boom and the
Return of the Ordinary Economy, Sources: Every U.S. President Promises To Boost
Economic Growth. The Catch: No One Knows How, and Why the Economy Doesnt
Roar Anymore).

Demographics
The U.S. population growth was high following WWII, but has fallen in half. This will
contribute to slower growth and the return to ordinary performance. Increasing
immigration restrictions will have benefits, but also adds to the headwinds through
less population growth and reducing the availability of low cost un-skilled labor.
 Population Growth and Birth Rate

The world population growth rate peaked in 1962 at 2.1%. The projected growth
rate in 2100 is expected to be near zero. (Source: World Population Growth). Since
population growth is a primary driver of economic growth, it will slow.
Arable Land per Person (hectares per person)

Source: The World Bank

Productivity
From the FRED database shown below, Real Output per Hour (OPHNFB) grew at an
annual rate of 2.8% from 1947 to 1973, but only 1.8% after 1973. The chart shows
the relationship between investment and productivity. Real GDP grew at an annual
rate of 4.0% from 1947 to 1973, but only 2.7% after 1973. Mr. Levinson attributes
the slower growth to the low base after WWII. For example, employment in
agriculture was 8.3% of the workforce in 1947, but only 1.0% in 2009. Increases in
productivity, among other factors has resulted in finance, insurance, and real
estate, professional and business services, and education, health care and social
services growing collectively from 15.7% of the work force in 1947 to 41.8% in
2009. (Source: Where Did All the Workers Go? 60 Years of Economic Change in 1
Graph, by Derek Thompson, The Atlantic, 2012)
Private Domestic Investment and Real Output

Some studies of the slowdown in economic growth and productivity beginning in

1973 attributed the main causes to the end of the population shift from low
productivity farm labor and self-employed jobs and the effects of recessions. More
modest contributors were attributed to declines in investment, more regulations,
high oil prices, decline in labor quality, and less nondefense R&D investment.
(Source: The U.S. Productivity Slowdown: What the Experts Say by William
Cullison, Federal Reserve Bank of Richmond, 1989)

Savings and Investment

Bruce Arnold of the Congressional Budget Office described in 2000 that prior to
1970, U.S. industry had little to fear and much to gain from free trade, because of
the devastation caused by WWII. He attributed the growing trade deficit of the time
to imbalances in the savings and investment rates, fluctuations in the business
cycle and attractive investment opportunities in the U.S. more than to trade
policies. He cautioned that the price tag for foreign capital invested in the
United States was the outflow of interest payments, profits and dividends.
He describes that a downward trend in domestic savings after WWII led to a
shortage of funds for domestic investment which caused inflation adjusted interest
rates to rise attracting foreign financial capital resulting in higher exchange rates.
Increased consumption and investment put upward pressure on the price of U.S.
output compared to other countries. He wrote, Trade policy normally has little
if any effect on the trade deficit because it does not affect saving and
investment. (Source: Causes And Consequences Of The Trade Deficit: An
Overview by Bruce Arnold, Congressional Budget Office, 2000)
The figure below shows the decline in savings as a percentage of gross national
income beginning in the early in the early 1980s.

The next chart shows investments and research and development as a percent of
GDP. R&D increased until the early 1960s, declined in the 1970s, received a boost
in the Technology boom and has declined afterwards. Investment increased as a
percentage of GDP until the early 1980s and has since declined. There was a
temporary in R&D increase during the Technology and Housing booms.
 Investment and R&D

Income Inequality
The slower U.S. growth since 1973 has been accompanied by rising income
inequality and by a stagnation of middle class incomes. The reasons often cited for
income inequality are pro-capital tax reform, declining high paying jobs such as in
manufacturing, decline in labor unions, opportunities brought about by new
technologies, fiancialization, globalization including increased competition and
immigration of low skilled workers, shifting from low-skilled jobs to higher skilled
jobs such as information technology, rising historical real estate and stock market
returns.
(Source: Income inequality in the United States, Wikipedia)

Globalization
The Bretton Woods system of fixed exchange rates constrained nations to maintain
balanced trade. When it ended in 1973, exchange rates were allowed to float. The
chart below shows the Current Account/GDP (blue) compared to the trade weighted
dollar (red, inverted scale). The recovery from the 1981 global recession and U.S.
budget deficit led to higher interest rates (through 1984) to attract capital. The
result was a 40% rise in the dollar exchange rate from 1980 to 1985. This helped to
increase the trade deficit. (Source: The United States Trade Deficit, by U.S.
Department of State, 2016)
Education
Education levels have been increasing for many years and will not have the same
strong impact on productivity as it did post WWII. The next chart shows that
employees with some college has grown from 52% as a percent of the work force in
1992 to 68% currently.
Employment by Education

Unemployment of college graduates is only a third of the rate of those without a

high school diploma. The U.S. is near full employment of skilled labor. (Source:
Bureau of Labor Statistics, by United States Department of Labor, 2016)
I am currently listening to The Unfair Trade: How Our Broken Global Financial
System Destroys the Middle Class by Michael Casey in which he describes the
migration of 200M rural workers in China to urban areas. Manufacturing workers in
China make approximately $300 per week without many of the social benefits like
those in the US. Shipping costs must also be incurred getting the exports to the US.
Once in the U.S., they enter into the distribution and retail systems which benefits
U.S. companies and employees.

Impact of Recessions and Shocks

Causes and severity of recessions vary as shown in the chart below. The recession
exasperated by the 2009 financial crisis was one of the most severe since WWII. I
combined the double dip recessions of 1980 and 1981 into one. Shocks such as high
oil prices in 1973, high interest rates (1980) and crises (2007) tend to have worse
effects than normal economic slowdowns.
The following chart shows that oil prices are as high this century as during the
1970s on an inflation adjusted basis. It was the sudden increase from the embargo
that created the shock.

Employment Growth and Automation

Borrowing an idea from Seeds of Destruction, I plotted the rolling 10 year average
of jobs created per percent of real GDP growth. The rate of job creation peaked in
the 1970s and began slowing in the early 1980s. The severe impact of the financial
crisis on job growth is obvious. The slowdown coincides with an increase in the trade
imbalance, loss of manufacturing jobs, flattening of real median incomes, and
increasing technology innovations. It is not just manufacturing jobs, but online
sales, kiosks at airports and in restaurants and stores, outsourcing of payroll
processing and information technology, and now Amazon Go among others.
(Source: Seeds of Destruction: Why the Path to Economic Ruin Runs through
Washington, and How to Reclaim American Prosperity, by R. Glenn Hubbard and
Peter Navarro, 2010)

The Future of North American Trade Policy: Lessons from NAFTA conducted by
Boston University with participants from Canada, Mexico and the U.S. found that,
Since 2000, however, North American manufacturing has shown a
competitiveness problem. The region as a whole has lost more than one-
quarter of its manufacturing jobs, and the downward trend predated the
current recession. The report also found that NAFTA has done little to create jobs
and stem the migration of people.
The chart below came from the Pardee Center Force Report on NAFTA. It shows that
there has been a decline in manufacturing jobs across the region, lending credence
to the claim that automation is the cause of much of the loss of jobs or that the
North American Region has lost jobs to overseas countries.
 Manufacturing Employment, NAFTA Region

(Source: Pardee Center Task Force Report, No. 1, November 2009

Debt and Consumption as Drivers of Growth

The boom following WWII was propelled by increased spending as a percentage of
GDP (red), but also financed by increases in household (blue) and federal (green)
debt. The savings rate fell in half. The past 10 years has experienced deleveraging
by households and a flattening in consumption. Deleveraging makes lowering
interest rates less effective when trying to stimulate economic growth because
some borrowers have the goal of reducing debt regardless of the cost of borrowing.
WELFARE STATE

Ben Bernankes quote from April 2010 in The Seeds of Destruction is worth
repeating:

To avoid large and unsustainable budget deficits, the nation will ultimately
have to choose among higher taxes, modifications to entitlement programs
such as Social Security and Medicare, less spending on everything else from
education to defense, or some combination of the above. These choices are
difficult, and it always seems easier to put them off-until the day they cannot
be put off any more.

Below is the projected revenues and outlays for social security. Large increases in
outlays will start this year. Benefits will have to be reduced around 2029 unless
something changes. They estimate that Social Security and Major Health Care
Programs as projected will grow from 10.4% of GDP in 2016 to 12.6% in 2026.

(Sources: Financial Sense: The Imminent Multi-Trillion Dollar Surge In Social Security
& Medicare Costs by Daniel Amerman and Congressional Budget Office)
To put this in perspective, social security, Medicare and Medicaid, and other social
benefits have grown from 5% of GDP in 1960 to 15% now and as the previous CBO
chart shows, are expected to continue growing to 2030.

Navarro and Hubbard favor increasing growth to reduce the burden of social
benefits. They suggest exempting capital gains, dividends and interest for
individuals from taxes and allowing corporations to expense capital investment to
reward saving and capital investment. They argue that reforms to structural
imbalances of overconsumption, underinvestment, and excess government
spending and chronic trade deficits can improve long term growth that will increase
the rate of growth as an alternative to those suggested by Mr. Bernanke.
To resolve the Social Security spending gap, they propose changing the index used
to index benefits from wages to prices because wages typically rise faster than
prices. The Wage Index used by Social Security has increased at an annual rate of
4.58% from 1955 to 2014 while the Consumer Price Index for All Items has
increased at a 3.76% rate. They also propose raising the retirement age to reflect
the longer life span. As shown below, the percent of the workforce aged 55 and
older has doubled in the past 16 years. People work longer because they are able
to, want to, or have to.
Navarro and Hubbard propose shifting the focus of the Affordable Care Act from
expanding coverage paid for with increased taxes to cost containment. Instead of
fee-based reimbursement they propose support focused on lower-income individuals
and less support for the more affluent. Another key focus is to shift from expensive
employer provided insurance programs to using pre-tax dollars for the consumer to
be more sensitive to health care spending. Health Savings Accounts seem to
accomplish at least part of this as a tax-advantaged savings account for high
deductible health plans.
The Congressional Budget Office lists 115 ways to reduce the deficit. Over a half
trillion dollars of potential savings over the next 10 years are listed for Social
Security including using alternative measures of inflation for indexing, index to
average prices instead of earnings, reducing benefits for new beneficiaries, and
eliminating supplemental benefits. Other options are to convert assistance for
lower-income people into smaller block grants to states, eliminating concurrent
payment of retirement pay and disability compensation to veterans and tightening
eligibility for the Supplemental Nutrition Assistance Program. To reduce
discretionary spending, the CBO lists reducing the military, funding for the
International Affairs programs, eliminating Head Start and the space programs. To
increase revenue, the CBO lists imposing a 5% Value-Added Tax (VAT), limiting
itemized deductions and deductions of state and local taxes, imposing a greenhouse
gas emissions tax, increasing payroll and social security taxes, taxing financial
transactions and increasing excise taxes. (Sources: Congressional Budget Office and
The Cost Of U.S. National Debt by Jeff Klearman, 2016)
I believe the solution to entitlements lies in encouraging more savings as discussed
in the next few paragraphs. The 401(k) was created in the Revenue Act of 1978 to
supplement retirement. By 2013, there were 89 million participants with $4.5T in
assets. David Dayen points out that the gradual retirement of workers receiving
defined-contribution plans instead of defined-benefit plans is a slow moving time
bomb because people are not saving enough. (Source: The Retirement Revolution
That Failed: Why the 401(k) Isnt Working, by David Dayen, 2016)
Monique Morrissey wrote a great article analyzing retirement savings plans. The
chart below shows the reliance on social security for low income people 65 and
older and the importance of working longer and having higher savings for higher
income people. (Source: The State of American Retirement by Monique Morrissey
at the Economic Policy Institute, 2016)

Saving for retirement is a lifetime of choices for many people such as working
overtime, going to college, participating in savings plans, increasing their savings
rate, taking that vacation, buying that latte instead of brewing a cup at home,
buying a new or a second car, changing jobs, or going to the lounge after work.
Reasons often given for not saving for retirement are not making enough money,
saving for college, expectations that social security will cover retirement costs,
expected lower expenses in retirement, lack of knowledge of investing, its too late
to start, paying off debt, there is plenty of time to start, my employer doesnt offer a
plan, my parents died young, planning on working longer, being too busy,
expectations of inheritance, expectations of successful career, reliance on home
equity, dire expectations of the economy, current spending desires, expecting
employer plans to suffice. AON Hewitt conducted a study of savings plan in 2014.
Savings plans with automatic enrollment have a participation rate of 85% while
plans without automatic enrollment have a participation rate of 62%. Nearly a
quarter of the participants have borrowed on average nearly 20% of their balance.
(Sources: 2014 Universe Benchmarks Measuring Employee Savings and Investing
Behavior in Defined Contribution Plans by AON Hewitt and Americans dont save
enough. Is this how we change their minds?, by Allison Schrager, Quartz, 2016)
AON Hewitt offers suggestions on how to increase participation, savings rates,
investment returns and final savings. These include more automatic enrollment,
increasing the contribution to receive the employer matching contribution, adding
the Roth option, and increased target communication to participants. To improve
investment returns, they advise reviewing the fund options, providing advisory
services, and providing lifetime income options. They also advise limiting access to
the funds through loans. I favor the Australian system which invests 9.5% of wages
into individual accounts.

DEBTOR NATION
Since 1982, Federal Total Public Debt has risen from $1T to nearly $20T now as
interest rates on the 10 year Treasuries fell from 15% to under 2% in 2016. Interest
payments on this debt have climbed to $350B (FRED). Because of lower interest
rates, interest payments have fallen from 15% of Government Total Expenditures
down to 7.5%. As interest rates normalize closer to 4% the cost of interest
payments is going to rise competing with other expenditures.

Craig K. Elwell describes in a Congressional Research Service report, why capital

flows have a stronger effect on the exchange rate than trade of goods and services.
In the global economy with large and fluid trade in goods and assets, countries with
high savings compared to investment must buy dollars to buy U.S. assets like
treasuries which increases the demand for dollars and increases the exchange rate
of the dollar making U.S. exports more expensive and exports of the other country
less expensive. He believes that trade policies using tariffs will be largely ineffective
because of the resulting impact on the exchange rate. The high savings rates of
some countries like China and Germany and the low savings rate in the U.S. results
in a stronger dollar and the trade imbalance. Asset market transactions occur much
faster and on a larger scale than goods and services transactions. Central banks
and investors perceptions can also influence exchange rates. Mr. Elwell says that
research on the low rates of saving in the U.S. have been attributed to 1) high
capital gains taxes on real estate, stocks and other investments, 2) Medicare and
Social Security transfer payments, 3) abundant access to credit markets, and 4)
government deficits. (Source: The U.S. Trade Deficit: Causes, Consequences, and
Policy Options 2010, by Craig K. Elwell, Congressional Research Service, 2010)
The rest of the world is holding $6T in U.S. treasuries on which we are paying $100B
a year in interest payments. The federal deficit in 2015 was $438B. A Congressional
Research Service Report for Congress put it this way, The cost of the trade
deficit is a deterioration of the U.S. investment-income balance, as the
payment on what the United States has borrowed from foreigners grows
with its rising indebtedness. Borrowing from abroad allows the United States to
live better today, but the payback must mean some decrement to the rate of
advance of U.S. living standards in the future. (Source: The U.S. Trade Deficit:
Causes, Consequences, and Cures 2007, by Craig K. Elwell, Congressional Research
Service, 2007)
Beginning in the early 1980s, the U.S. trade deficit became negative (green), the
federal deficit began to rise (cyan), the U.S. increased its borrowing from the rest of
the world (red). Now interest payments to the rest of the world on U.S. Treasuries is
$100B (blue).
As described in the definition section, the Net International Investment Position
(NIIP) is the total of U.S.-owned assets in other countries minus the total of foreign
owned assets. There are different methods for calculating NIIP such as based on
historical cost. It does not represent a debt, but net investment position. Equity is
included so profits accumulate to foreigners. According to Bruce Arnold, The size
and growth of the negative NIIP have prompted concerns about whether foreigners
continue to finance the trade deficit and how a negative investment position affects
the stability of the economy. (Source: Causes And Consequences Of The Trade
Deficit: An Overview, by Bruce Arnold, Congressional Budget Office, 2000)

The Net International Investment Position to GDP ratio and current account to gross
domestic product are measures of borrowing constraint.

COMPANIES MOVING ABROAD

The S&P 500 gets about 45% of its revenue from foreign operations and pays over
two thirds of its taxes to the US. Payment of taxes to foreign countries declined
nearly 20% from 2012. The following table is from the S&P 500 2015: Global Sales
which shows the decline in taxes to foreign countries compared to the increase to
the US. Notice that taxes paid to foreign countries is about the same in 2015 as in
2009, while taxes to the U.S. have doubled. (Source: S&P 500 Global Sales, by
Howard Silverblatt, 2015)

There have been at least 73 companies that have moved headquarters overseas
since 1983. Since the start of 2000, 59 companies have moved headquarters
abroad. Of the 38 companies with revenues shown, this represents $750 billion in
revenue. Fifty-six of these companies have moved to Bermuda, Cayman Islands, or
Ireland. (Source: These are the companies abandoning the U.S. to dodge taxes, by
Danielle Douglas-Gabriel, The Washington Post, 2014)
Referring to tax laws for international companies, President Obama said, A lot of
its legal, but thats exactly the problem, its not that theyre breaking the law. Its
that the laws are so poorly designed. The U.S. top corporate tax rate is 35 percent
compared to 20 percent for Britain and 12.5 percent for Ireland. In addition, U.S.
based companies are taxed on global profits when they repatriate the money home.
This has resulted in over two trillion dollars in cash accumulated overseas by U.S.
multinational companies. (Sources: Obama administration cracks down on
companies moving abroad for lower taxes and Burger King-Tim Hortons deal: 5
questions answered, U.S. Companies Are Stashing $2.1 Trillion Overseas to Avoid
Taxes, Whats Driving American Firms Overseas)
Average and top tax rates can be misleading. There may be tax loopholes that
reduce the taxes that fall in the top tax brackets. However, high tax rates impact
the more profitable companies. Lance Roberts points out that according to the
Government Accountability Office the average tax rate paid by U.S. corporations is
about 12.5% even though the top rate is 35%. When state and local taxes are
added, the average taxes paid by corporations is 16.9%. (Source: 3 Things: Policy
Hopes, Puppies And Rainbows, by Lance Roberts, Seeking Alpha, 2017).
The chart below shows that Federal tax receipts on Corporate Income as a percent
of profits and as a percentage of national income has been declining since the
1950s. The trend upward since 2009 matches what is reported by the companies in
the table above for S&P 500 companies.
Of the cash held overseas, Goldman Sachs and others point out that about 45% of
corporate cash is used for stock buybacks and dividends and a tax repatriation will
likely increase these purchases. The remainder would likely go to acquisitions, R&D
and capital investments. Secondly, less than half of the two trillion dollars is likely to
be repatriated with the rest used to finance overseas operations. Some analysts
believe that tax holidays encourage these companies to relocate outside of the US.
The profits of offshore subsidiaries can be invested in U.S. treasuries and corporate
stock without being repatriated. Without a tax holiday, U.S. firms are now
repatriating about a $100B per year. (Sources: Goldman: How Corporations Will
Spend Their Huge Piles of Overseas Cash, Repatriation Tax Holiday Would Lose
Revenue And Is a Proven Policy Failure, Offshore Corporate Profits: The Only Thing
Trapped Is Tax Revenue

That Confusing Value Added Tax (VAT)

The Value Added Tax is one of the politically charged topics. The VAT is a
consumption tax based on the value added at each stage of production and is used
by over 160 countries. It can be considered a replacement of the sales tax used in
the US. To counter the impact of double taxation when goods are exported from one
country that does have VAT to another that uses sales taxes, imported goods are
charged a VAT tax for their full price when they are sold for the first time and all
exported goods are exempted from any VAT payments. Much of the confusion over
the tax comes from evaluating a product that includes VAT taxes to a product of an
equal value that has not yet had the sales applied. (Source: Value-added tax at
Wikipedia)
What does this mean? Countries with VAT tax their own companies on their products
at every stage. When the U.S. exports to these countries, the products have not
been taxed and so imports into the countries have the VAT applied. Exports of the
U.S. are taxed as are the products produced in those countries. Products that are to
be exported to the U.S. already have the VAT applied, so these taxes are rebated. In
the U.S., the sales tax is then applied to the imported products when sold. Also
adding to the confusion is the economists argument that in the long run, these
border-adjusted taxes cause the currency to adjust accordingly negating any effect
on the value of imports and exports. Adjustments in the long run dont help the
exporter in the short run. (Source: Ryan and Trump Are Both Wrong About Trade
Taxes, by Ramesh Ponnuru, BloombergView, 2016)
Products imported from Mexico have the VAT tax repealed at the border, as the
system works. The destination country then applies its taxes. The problem, is that
the Mexican VAT is 16% while the sales tax is applied on a state basis with California
having the highest sales tax of just over 7%. Some states do not have a sales tax.
Japan raised its VAT tax from 5% to 8% in 2013 and is planning on raising it to 10%
this year. Meanwhile they have dropping their corporate income tax rate from
39.5% to 29.7%. (Source: Trump Wants to Exempt U.S. from Mexicos VAT? The
Real Antidote Is a VAT of Our Own, VAT Info, 2016)
Michael Nicholson evaluated the impacts of VAT and U.S. trade competitiveness in
2010 and said some economic evidence suggests that the United States
may be able to improve its business competitiveness if it were to replace
certain elements of its existing tax structure, particularly the corporate
income tax, with a border-adjustable tax. The World Trade Organization
recognizes border adjustments on indirect taxes (ie VAT) to ensure neutrality of
trade. However the WTO does not allow border adjustment for direct taxes like
corporate income that the U.S. uses. He concludes The U.S. corporate income
tax tends to decrease exports and increase imports. (Source: Value-Added
Taxes and U.S. Trade Competitiveness by Michael W. Nicholson, U.S. Department of
Commerce, 2010) The VAT is a method of global integration and tax reform
proposals move the U.S. corporate tax to be more of a consumption tax like the VAT.

TAX REFORM AND SPENDING

The U.S. has a high top corporate rate, but as shown below, corporate taxes as a
percentage of GDP in the U.S. have been lower than the average of the OECD
countries since the 1980s. Again, the difference is narrowing since 2009. Notice the
tax reforms of the 1980s reduced the U.S. tax burden on corporations.
Source: OECD

As a starting point for discussing taxes, the following chart shows the sources of tax
revenues. Corporate income taxes are small compared to personal taxes and state
and local taxes. Total U.S. tax is 26% of GDP compared to 34% for developed
countries. The U.S. collects 48% of its revenue on income and profits compared to
34% among developed countries which tend to use taxes on goods and services (ie
sales and VAT taxes) more than in the US. (Source: Tax Policy Center). The average
combined payroll tax (employee and employer) rate in the U.S. is 15% while the
combined rate in the OECD was 23% percent. The total tax burden for U.S. workers
is 31.7% compared to 35.9% for the OECD countries. (Source: Tax Foundation)

Ben Bernanke recently wrote, referring to potential fiscal stimulus that, its not
clear that the near-term macroeconomic effects of fiscal changes will be large, even
if major legislation passes. He points out that much of the proposed tax cuts will
benefit the wealthy and not likely to benefit growth of consumption. He adds that
higher interest rates and stronger dollar will have an adverse effect on fiscal
changes. (Source: The Fed and Fiscal Policy, by Ben S. Bernanke, Seeking Alpha,
2017)
John B. Taylor argues that discretionary countercyclical fiscal stimulus is not very
effective and may actually be destabilizing. Instead he argues that higher economic
growth requires tax, budget, regulatory and monetary reform. He states there have
been fiscal stimulus programs implemented in the 1970s as well as in 2001, 2008/9
and 2012 including federal transfers to the states for infrastructure building, tax
rebates, income tax cuts and financial aid for home buyers. Economic performance
during these time periods was disappointing. (Source: A Turning Point in American
Fiscal Policy: Fiscal Stimulus or Structural Reform? by John B. Taylor, 2016)
The chart below shows two models that estimate the impact on GDP of a permanent
increase in government purchases equal to 1% of GDP showing a wide discrepancy
in methods. Taylor believes that temporary stimulus may have a short-term boost to
the economy without promoting sustainable recovery while leaving the economy
with more debt. He analyzes the effect of cutting government spending including
entitlements to reduce the debt to GDP ratio and implementing cutting personal and
corporate tax rates. Dr. Taylor concludes, Recent experience with fiscal
stimulus programs in the United States raises considerable doubts about
the efficacy of such programs in practice.

Dr. William McBride reviewed 26 studies about the impact of taxes on economic
growth. Almost all found a negative impact of higher taxes on growth. Corporate
income taxes are the most harmful followed by personal income taxes consumption
taxes and property taxes. He finds taxing higher incomes at higher rates reduces
investment, risk taking, and entrepreneurial activity since a large share of these
activities are done by high income earners. He believes that long-term growth is
highly impacted by tax policy. As an examples, an IMF study found that a 1% tax
increase reduces GDP by 1.3% after two years and reducing corporate income taxes
1% raises annual growth by 0.1 to 0.2%. (Source: What Is the Evidence on Taxes
and Growth? by Willian McBride, Tax Foundation, 2012)
State and Federal taxes (blue) have been falling as a % of GDP, but federal revenue
shortfalls are made up with the budget deficit (red). Yet, as shown previously, long-
term real GDP growth has slowed from 4% to 2%. Part of the success of the 1981
Reagan years through to the Tech Bubble was due to corporate bond rates falling
from 13% to 7% by 1999, federal debt increasing from 31% to 64% by 1995,
Household debt to Disposable income increasing from 66% to 95% by 1995, and the
top tax rate falling from 70% to 33% among other factors such as de-regulation.

Effects of Income Tax Changes on Economic Growth states that the net impact of
tax rate cuts on long-term growth is small and if they are not financed by immediate
spending cuts will probably increase the budget deficit. The authors say that
reforms that improve incentives, reduce existing distortionary subsidies, windfall
gains, and avoid deficit financing will have the largest effects. A fair assessment
would conclude that well-designed tax policies have the potential to raise economic
growth, but there are many stumbling blocks along the way and certainly no
guarantee that all tax changes will improve economic performance. (Source:
Effects of Income Tax Changes on Economic Growth by William Gale of the
Brookings Institution and Tax Policy Cent and Andrew Samwick of Dartmouth College
and NBER, 2014)
Rudolf Macek studied the impact of taxes on economic growth in OECD countries
from 2000 to 2011. He found that government spending reduces economic growth,
probably due to crowding out and to unproductive spending. He concludes that the
corporate tax is most harmful followed by personal income taxes and then by social
security contributions and finally by the value added tax. (Source: (The Impact of
Taxation on Economic Growth: Case Study of OECD Countries by Rudolf Macek,
Review of Economic Perspectives, 2015)
Davide Furceri and Georgios Karras believe that there is strong agreement about the
effect of taxes on economic growth while the exact mechanisms for this is less
understood. They estimate that from 1965 to 2003 using 26 OECD economies that
increasing taxes lowered long term GDP per capita by -0.5% to -1%, but the effect is
much larger on investment. (Source: Tax Changes And Economic Growth: Empirical
Evidence For A Panel Of OECD Countries by Davide Furceri and Georgios Karras)

In a report prepared for Tax Policy and the Economy, Alberto Alesina and Silvia
Ardagna make the case that there is relatively little known about the impact of fiscal
multipliers for tax cuts and spending, but that the topic is politically charged.
Economic growth does decrease debt to GDP levels rapidly. They find that tax cuts
are more expansionary than spending increases in the cases of a fiscal stimulus and
for deficit reductions spending cuts are much more effective than tax increases in
stabilizing the debt and avoiding economic downturns. (Source: Large Changes in
Fiscal Policy: Taxes versus Spending, by Alberto Alesina and Silvia Ardagna, NBER,
2009)

The National Bureau of Economic Research published a working paper on fiscal

multipliers and found little impact of government consumption because it was also
slow to take effect and was less effective in open economies with flexible exchange
rates. They found that fiscal stimulus can be counterproductive in highly-indebted
countries. They also found government investment to be more effective than
consumption. (Source: How Big (Small?) Are Fiscal Multipliers? By Ethan Ilzetzki,
Enrique Mendoza and Carlos Vegh, NBER, 2010)

The chart below shows that lowering top marginal tax rates and effective tax rates
on capital income has not stemmed the decline in net savings of the past 60 years.
 Tax Rates and Labor Force Participation

(Source: Tax Rates and Economic Growth, by Jane G. Gravelle and Donald J.
Marples, Congressional Research Service, 2014)

The chart below shows the relationship between Federal fixed investment and real
GDP. It may be the right thing to do, but the relationship is either not strong or
requires time for the effects to be realized.

The Congressional Budget Office produced a working paper which describes the
accuracies and limitations of estimating multipliers for fiscal spending. The table
below lists estimates for the American Recovery and Reinvestment Act of 2009.
Purchases by the Federal Government and infrastructure spending will have the
largest effect followed by transfers to individuals and the tax cuts to lower and
middle income people. Tax cuts for higher income people, extension of First-Time
homebuyer credit and corporate tax provisions would have the lowest multiplier
effect. (Sources: The Fiscal Multiplier and Economic Policy Analysis in the United
States by Charles J. Whalen and Felix Reichling, Infrastructure Spending and the
Fiscal Multiplier by Anika Khan at Wells Fargo and The Fiscal Multiplier: Econ 101)

TRADE
This busy chart puts investment and trade into perspective. There is nearly $4T of
foreign direct investment in the U.S. and foreigners own $6T of Federal Debt. Gross
Domestic Investment is $3T per year. Exports are $2.3T per year and imports are
$2.7T per year for a trade deficit of about $0.4T. The Federal Deficit is close to $0.6T
per year. At the turn of the century, $1U.S. would buy 8.3 Yuan compared to 6.7
now, making imports from China more expensive.

The Importance of Trade

There are businesses that benefit from exporting (13% of GDP) and those that
benefit from importing (15%). Some industries and localities will benefit from trade
protection and others will suffer.

Below, the trade deficit is added back to GDP growth reflecting how small a percent
of GDP it is.

The current account (red and blue) is compared to the exchange rate. For the past
couple of years, the exchange rate has been rising and the current account deficit is
becoming larger.
Multinational Corporations, Mobile Capital and International Taxes
Ernst & Young analyzed more than 5,000 business investment announcements in
2015 accounting for more than $166B in investment and 400 thousand new and
retained jobs in the US. Top investment trends are a resurgence of automotive
manufacturing outside of the upper Midwest, development of New Yorks Tech
Valley and continued attractiveness to foreign investors ($36B or 22% of the
investments monitored). The largest investments were in natural gas-related
industries and New Yorks Tech Valley. Green growth and headquarter facilities
also saw considerable growth. Projects costing less than $10M created slightly more
than half of the jobs. Taiwan, South Africa, Germany, Austria, Japan, Canada,
Denmark, Netherlands and China, listed in decreasing order, each invested more
than $1B. E&Y cites the stronger dollar as a possible deterrent to foreign
investment. (Source: 2016 U.S. Investment Monitor, by Ernst & Young LLP)
Multinational and transnational companies make up a significant amount of foreign
assets and sales. In 2013, the U.S. companies in the top 100 global multinationals
owned nearly $2T in foreign assets. Much of the imports and exports between
countries is done through intra-corporate sales between the parent and/or affiliate
businesses. The largest U.S. multinational (2013 data) is General Electric with
$331B in foreign assets and foreign sales were 53% of its total sales. Oil companies
Exxon, Chevron, and Conoco had $460B combined. Technology companies Apple,
Microsoft, IBM, Hewlett-Packard and Google had nearly $300B in foreign assets.
(Source: The Worlds Top 100 Non-Financial TNCs Ranked by Foreign Assets, 2014)
In 2014, 10% of importers were multinational companies which accounted for over
75% of imports. There were over 400,000 companies importing or exporting with
20% of the companies both importing and exporting. Large companies (6% of the
84 thousand companies that import and export) represented 73% of the imports.
Multinational manufacturing firms that both import and export accounted for
approximately half of the total imports. (Source: A Profile of U.S. Importing and
Exporting Companies, 2013 - 2014, by Glenn Barresse, Benjamin Shelak, Ramon
Pineda or Sherri Ewing, U.S. Census Bureau News, U.S. Department of Commerce,
2016)
Estimates of the intrafirm trade as a percent of total trade are subject to
measurement error tracking trade across borders. The estimates of intrafirm share
of total trade range from 35% to 50%. (Sources: Globalization and trade flows:
what you see is not what you get! and An Overview of U.S. Intrafirm-trade Data
Sources)
The following figure is an estimate of the share of intra-firm imports compared to
total imports leading up to the financial crisis. The share of intra-firm transactions in
trade between the U.S. and other OECD (developed) countries is much higher than
in emerging economies. Low labor costs does not appear to be the primary driver of
foreign direct investment. Over 55% of the imports from Mexico are estimated to be
intra-firm while over 35% of the exports to Mexico are estimated to be intra-firm.
High income taxes are an incentive for multinational firms to estimate higher costs
of imports in order to have lower profits subject to higher income taxes. The U.S. tax
code is burdensome enough, and these multinational firms must deal with tax
systems of more than one country raising administrative costs. (Source Intra-Firm
Trade Patterns, Determinants and Policy Implications by Rainer Lanz and Sbastien
Miroudot, OECD Library, 2011)

Gabriel Zucman in the Journal of Economic Perspectives provides the best

description of international taxation with respect to multinational corporations that I
ran across. The U.S. corporate effective tax rate over the past 15 years has fallen
from 30% to 20% and Mr. Zucman estimates that about two-thirds of this decline is
due to shifting profits to low-tax jurisdictions as a legal avoidance of taxes.
Corporate taxes are harder to inforce than consumption taxes (ie VAT) and most
countries rely more on consumption taxes. The following figure shows his estimates
of the profits derived abroad in U.S. corporate profits. One way that profits are
shifted is for subsidiaries in low-tax countries to grant loans to subsidiaries in high-
tax countries and another is in the manipulation of internal exchanges of goods and
services. (Source: Taxing across Borders: Tracking Personal Wealth and Corporate
Profits by Gabriel Zucman, Journal of Economic Perspectives, 2014)

Mr. Zucman created the figure below showing the share of U.S. multination firms
profits from tax havens. He then estimates that the share of tax havens in U.S.
corporate profits has climbed to nearly 20% (2008 -2012). He estimates that the
percent of U.S. equity market capitalization held by tax haven firms and individuals
to have risen from about 2% in 1980 to 10% by 2010. The amount of wealth held by
foreigners in Switzerland was over $2T in 2014. Mr. Zucman estimates that
8 percent of the global financial wealth of households is held in tax havens and is
increasingly being concentrated with ultra-high net worth individuals. In 2010, the
U.S. Congress enacted into law the Foreign Account Tax Compliance Act to compel
foreign banks to disclose accounts held by U.S. taxpayers.
There appears to be a significant increase in corporate profit shifting over the past
several years. The loss in tax revenue may be over $100B per year. The cost of tax
evasion of individuals using foreign tax havens is estimated to be between $40B
and $70B per year. The Hiring Initiatives to Restore Employment (HIRE) Act and the
Stop Tax Haven Abuse Act focus on reducing individual tax evasion. One of the
problems is that the U.S. does not withhold tax on many types of passive income
paid to foreign entities. A list of tax haven countries compiled from the OECD, IRS,
and Government Accountability Office lists is shown below. (Source: Tax Havens:
International Tax Avoidance and Evasion by Jane Gravelle, Congressional Research
Service, 2015)

The countries in the list above with a GDP of $25B or more plus the Netherlands
account for 40% of earnings but only 4% of rest-of-world GDP indicating that they
have a disproportionate share of earnings given their small economies. Five of the
10 countries with the most foreign multinational profits had effective tax rates
below 12% while the other 5 including Mexico had effective tax rates in excess of
23%. The cited report lists policy options for tax reform.
Intrafirm transfers comprise part of imports and exports and affect the domestic
content. Below, I show the U.S. direct investment by country. Most U.S. investment
has been going to tax haven countries such as Ireland, Luxemberg, Netherlands,
Switzerland, and Cayman Islands. Very little direct investment goes to countries
with large trade deficits like Mexico and China.

U.S. Direct Investment Abroad

In a similar fashion, the tax haven countries are investing back in the US. Countries
with large savings or exports such as Japan, Canada, Germany, France, and South
Korea are also investing in the US. The stronger dollar will put downward pressure
on foreign direct investment in the US.
 Source: Foreign Direct Investment in the United States

Major Trading Partners

The following charts shows how the imports of the U.S. have changed as a percent
of total imports over the past 30 years along with the trade deficits. Our neighbors,
Canada and Mexico, are our largest trading partners (left) along with China. The rise
of trading and imbalance with China (right) stands out.
By contrast, a third of U.S. exports go to Canada and Mexico. Exports to China have
been growing notably.

Source: United States Census Bureau

Causes of the Current Account Imbalance

James Jackson writes that the free flow of large amounts of dollars in the world
economy and international access to dollar-denominated assets, macroeconomic
developments, particularly the demand for and supply of credit in the economy, are
the driving forces behind the movements in the dollars international exchange rate
and, therefore, the price of exports and imports in the economy. (Source:
Financing the U.S. Trade Deficit, by James K. Jackson, Congressional Research
Office, 2016)
The idea for the following graph came from John Hussman who writes that the U.S.
relies heavily on the import of foreign savings to finance our gross domestic
investment and that increasing government spending such as on infrastructure
while restricting trade will restrain investment. The relationship is that historically, a
1% increase in the trade deficit (as a percent of GDP) comes at a time when Gross
Domestic Investment is increasing at 1.7%. He sums up that some policy shifts
could encourage greater productive investment and raise long term growth, but the
shift will not produce rapid, sustained growth in the next few years. (Source: The
Economic Risk Of Ignoring Arithmetic, by John Hussman, Seeking Alpha, 2017)
The Beneficial Side of Trade
Trade deficits are good when countries are making investments with the capital
inflows that accompany them. They can also be good when other countries are
producing goods and services that the U.S. does not have the capacity to produce.
However, the U.S. has high consumption and slow growth in investments which
lowers the benefits of running a trade deficit. Shifting production overseas does
result in unemployment in affected industries. The chart below shows that while the
current account has increased to -2.5% of GDP from 0% in 1980, capacity utilization
has been low and until recently unemployment above average. Mr. Elwell stated
in 2010 that excessive consumption may suggest a significant problem of
economic short-sightedness by households and government in meeting
the countrys future obligations [social security, Medicare, entitlements].
My sentiments exactly. (Source: The U.S. Trade Deficit: Causes, Consequences, and
Policy Options 2010, by Craig K. Elwell, Congressional Research Service, 2010)
Oil
When the dollar (red) declines as it did during the 2000s, the price of oil (blue)
increases which has a dampening effect on consumption growth (green). The price
of oil remained high (after falling during the financial crisis). In 2014, the stronger
dollar put downward pressure on the price of oil. The resulting low prices of oil had a
temporary effect of stimulating personal consumption while damaging U.S.
production and localities involved in production. Personal consumption growth
increased, assisted by low interest rates and low oil prices.

This chart shows the strong correlation between the dollar and oil prices during the
past 16 years. The relationship between interest rates, the dollar and oil prices often
has a countercyclical effect on monetary policy.
The Trade Imbalance with Mexico and China
Mexico and Canada are the largest trading partners of the U.S. Net exports are
balanced with Canada.
U.S. Imports and Exports with Canada and Mexico

Trade began increasing dramatically a few decades ago. Gross Domestic Product per
capita is high in the OECD developed countries, in particular the U.S., with the rest
of the world including China and Mexico much lower. China is not a wealthy country
and with state owned enterprises, its national goals of employment often over-ride
market driven goals.
Mexico is the second largest export market for the U.S. after Canada. Mexico has a
balanced current account with about $425B in both imports and exports. The U.S.
merchandise trade deficit with Mexico is $58B, mostly (32%) due to vehicles and
parts. Mexico imported $23.8B of motor vehicle parts from the U.S. in 2015. The
U.S. services surplus with Mexico is about $10B. The stock of Foreign direct
investment from the U.S. into Mexico was $93B and from Mexico into the U.S. is
$17B. The economic growth rate of Mexico is comparable (fluctuating between 2 to
4%) to that of the U.S. for the past 30 years. (Source: U.S.-Mexico Economic
Relations: Trends, Issues, and Implications, by M. Angeles Villarreal, Congressional
Research Service, 2016)
The OECD estimates that the import content of Mexico and Chinas exports is about
32% as shown below. Domestic content is over half of the value for manufactured
goods. (Source: What is Made in America? by Jessica Nicholson and Ryan Noonan,
U.S. Department of Commerce, 2014)
Domestic Content of Exports
 SOURCE: OECD, 2011
David Dollar writes in Brookings 2016 Election that Trade with China has led to
the loss of American manufacturing jobs, reduced real wages for semi-skilled
workers, and devastated some communities dependent on low-end manufacturing
jobs. Mr. Dollar points out that the U.S. has nearly balanced trade with the
countries in the proposed Trans-Pacific Partnership which does not include China.
These are more open economies and the U.S. has $1T invested in the TPP partners
which is 15 times more than in the closed China markets. He suggests policy
options to place restrictions on China investing in the U.S. because of Chinas
restrictions and closed markets. He adds that imposing tariffs on imports from China
will send those jobs to other developing countries instead of them returning to the
US. He suggests using the TPP as an incentive for China to reform, China is not one
of the negotiating countries, and it would be hard for China to meet TPP standards
because it would require the country to open up its trade and investment and
adjust other regulations. (Source: The Future of U.S.-China Trade Ties, by David
Dollar, Brookings, 2016)
A large part of the high growth rate in China has come from pegging their currency
rate to the dollar as shown below. Since 2015, China has attempted to weaken the
yuan against international currencies. The goal is to make exports more
competitive. In 2016, the yuan became part of the International Monetary Funds
special drawing rights (reserve currency) along with the dollar, yen, pound and euro.
The chart below shows that imports from China amount to nearly 4% of U.S.
consumption.

Walmart is the largest importer measured by the number of shipping containers.

The domestic content of its sales is about two-thirds. It has a goal of increasing
sales of U.S. produced goods by $250M over 10 years. Walmart has growing
business in China with more than 400 stores open and sales growth doubling in
2015. Walmart has a mobile app called Global E-Buy for online shoppers in China.
These products are stored in duty free zones the Chinese government created a few
years ago. Chinese consumers purchased nearly $600B worth of goods online in
2015. (Source: Wal-Mart sells imported goods in China via a mobile app and
Chinathe Worlds Largest E-Commerce MarketExtended Its Lead in 2015)
Wal-Mart de Mexico is Mexicos largest retailer and sales have increased nearly 12%
in 2016. They have over 2,000 stores in Mexico with sales of nearly $25B and
another 731 stores in Central America. (Source: Wal-Mart de Mexico's 2016 Sales
Rose 11.9%) Other U.S. retailers doing business in Mexico include Costco, Victorias
Secret, Starbucks, Burger King, McDonalds, Tasti Dlite, Cold Stone Creamery,
Wendys, YUM Brands, and Baskin-Robbins. (Source: Largest Mexico Retailers and
Department Stores, by Barbara Farfan, The Balance, 2016)
Amazon China now has a selection of 10 million imported items. The products are
from Amazons U.S. site. Amazon can deliver within 3 to 5 days if the products are
stored in the free-trade zone. (Source: Amazon China expands its selection to 10
million imported items by Frank Tong, Internet Retailer, 2016 and Amazon
Overseas Purchase)
Costco is also expanding abroad. It now has over 200 warehouse stores outside of
the U.S. located in the United Kingdom, Taiwan, Korea, Japan, Australia, Spain and
Mexico. They have 35 stores in Mexico. Source: Costco's Retail Innovation Craze,
by Barbara Farfan, The Balance, 2016)

A BETTER WAY and MAKING AMERICA GREAT AGAIN

We dont know what President Trumps economic agenda will be until later in the
year. There was a lot of political rhetoric during the election, but no detailed plan.
He has stated favor along the lines of cutting taxes, increasing military spending,
increasing infrastructure spending, increasing veteran benefits, getting rid of the
Affordable Care Act, while not affecting social security or Medicare for current
recipients.
In Scoring the Trump Economic Plan, Peter Navarro and Wilbur Ross estimated
that trade policy reforms would increase tax revenue by $1.7T over 10 years to
offset part of the revenue reduction forecast by the Tax Foundation. This is based on
the idea that eliminating the trade deficit through increased exports and reduced
imports will stimulate growth, create jobs, and encourage investment. (Source:
Scoring the Trump Economic Plan, by Peter Navarro and Wilbur Ross, 2016)
A Better Way (The Republican plan) proposes reduced taxes on capital gains,
dividends and interest income to increase savings. It proposes elimination of the
U.S. taxation of worldwide income of American-based global business. House
Republicans achieve revenue neutrality in part by including the positive revenue
effects from the economic growth that would result from a simpler, more pro-
growth tax code. Republicans see repeal of the Affordable Care Act as a way to
reduce entitlements and the additional taxes it imposes. (Source: A Better Way,
2016)
The Plan:

Eliminating the alternative minimum tax and the estate tax

Allows the ability to deduct half of net capital gains, dividends, and interest
incomes
Retain the earned income tax credit
Eliminates most itemized deductions for middle-income families (except
mortgage interest and charitable contribution)
Lowers the top tax bracket on small businesses
 Lower the top corporate tax rate; ability to immediately write off costs of
investments
Eliminates deductions for net interest
Net operating losses will be allowed to be carried forward indefinitely
Reduces deductions
Provides a credit to encourage research and development
Offset the impact of VAT taxes by not taxing exports while applying U.S. taxes
to imports into the US
Exempts dividends from foreign subsidiaries
Streamline and modernize the Internal Revenue System

The House Ways and Means Social Security Subcommittee introduced the Social
Security Reform Act of 2016 in December (Source: Social Security Reform Act of
2016)
The Act proposes:

Raising the retirement age to 69

Reduce benefits to higher income retirees
Change cost of living adjustments to Consumer Price Index
Reduce COLA to high income retirees
Reduce spousal benefits to higher income retirees
Increase minimum benefits to the lowest income retirees
Increase incentives to work longer

That Confusing Value Added Tax (VAT)

The proposals are intended to lower corporate taxes to 20% on domestically
produced products and services sold in the U.S. and to imported goods so that it
acts like the VAT. The VAT allows capital expenses to be deducted immediately
which is an inclusion in the tax reform. Additional confusion is added by the
combination of corporate taxes and VAT. The proposed border adjustment is based
on the destination where the product is consumed and not where the headquarters
is located. The proposal is that U.S. exports will not be subject to U.S. corporate
taxes but will be subject to foreign corporate taxes along with the VAT. Imports into
the U.S. will be subject to the foreign corporate tax and the U.S. would impose U.S.
corporate tax at the border while the Foreign VAT does not apply. (Source: GOP
Proposal to Change Tax Treatment of Imports and Exports Raises Questions, by
Richard Rubin, Dow Jones, News, 2016)
Wells Fargo describes changes in tax reform that they expect to be enacted in 2017.
They add that tax reform should be deficit-neutral. Corporate tax reform in the
House GOP Plan will reduce the top corporate tax rate from 35% to 20%, cap taxes
on pass-through businesses and the individuals at 25%, create a repatriation rate of
8.75% on cash and cash equivalent profits and 3.5% on other profits. The proposal
also changes the tax code to a destination-based system where U.S. multinational
corporations are exempt from tax on both domestic and foreign income generated
overseas. Economists at Wells Fargo believe that increasing infrastructure above the
$305B transportation bill approved in 2015 will be challenging. They estimate that
only $140B to $185B will be raised through tax repatriation which are already used
in the House plan for other uses. (Source: Key Issues to Watch in the 115th
Congress by Wells Fargo Securities, 2017)

In Headwinds for the Trump Economy, Robert Kahn and Steven A. Tananbaum,
point out that the Tax Policy Center estimates that the cost of President Trumps tax
plan could increase the federal debt by $7.2T over a decade, while Paul Ryans A
Better Way has more modest tax cuts mixed with spending cuts that are more
neutral on the deficit. They suggest that stronger economic growth can cover up to
a half percent of GDP of the increase in the deficit by increasing revenues.
According to Kahn and Tananbaum, academic and policy studies question the
effects of tax changes on economic growth in agreement with Marc Levinsons
assertion. Increased deficits are likely to increase upward pressure on interest rates
as the markets are currently anticipating which will have a dampening effect on
growth. (Source: Headwinds for the Trump Economy at the Council on Foreign
Relations, 2016)

Wells Fargo described in the Global Chartbook, In October, our full-year GDP
forecast was 2.2 percent for 2017 and 2.2 percent for 2018. Postelection, those
figures are unchanged. The big impact from the election is less about the actual
projected growth rate and more about the increased variability of potential
outcomes given the increased policy uncertainty.

CONCLUSION:
Trade and employment is more complicated than the U.S. is just being inundated by
cheap products that rely on cheap labor to displace American jobs. Low savings
rates in the U.S. and the high savings rates in some countries impact the exchange
rates making U.S. products more expensive. U.S. consumers have purchased
inexpensive products at the expense of savings which has shifted jobs overseas.
Multinational corporations and high net worth individuals take advantage legally or
unethically of tax havens. Corporate and trade reforms including transparency
should occur to correct this trend. Trade tariffs will be counter-productive and hurt
consumers and many employees and businesses.

DISCLAIMER:
I am not an economist, investment advisor nor investment professional. This
material is for informational purposes only and should not be construed as
investment, legal or tax advice. Investors should do their own research or seek the
advice of investment professionals.