Debating Bartlett: Would Raising Taxes Reduce Our Trade Deficits?

by: Howard Richman

In a recent blog entry (The National Debt and National Security), conservative economist Bruce Bartlett advocates raising taxes in order to reduce our trade deficits so that we can stop borrowing so much money from China.

Bartlett is clearly thinking about the right problems. In this blog entry he shows that he understands the negative national security implications of borrowing money from China. He also shows that he understands that trade deficits slow our economic growth. He thinks that raising taxes would balance our budgets which would cause us to borrow less money from China. His goal is to enhance domestic investment, specifically:

It's worth remembering that our government's fiscal profligacy is mirrored by the profligacy of our citizens, who do not save enough to finance domestic investment and appear loathe to reduce their consumption in order to save more. When any nation cannot finance domestic investment from domestic savings it has only two choices: import the saving and become indebted to foreigners or reduce domestic investment, which will lead to a lower standard of living.

Bruce Bartlett thinks that our low savings rate is caused by the government setting a bad example. But our low savings rate is actually caused by our low interest rate, which is caused by foreign savings being force-fed into our economy by the Asian central banks (especially the People's Bank of China).

Bartlett is correct that, other things being equal, lower interest rates do increase domestic investment. But he fails to understand that domestic investment requires investment opportunities, not just lower interest rates. The same mercantilism that causes our trade deficits also causes our low savings rate. If we were to require balanced trade, we would have higher investment, despite higher interest rates.

When we let the mercantilist countries force up the dollar exchange rate while keeping out our imports, we let them take away our investment opportunities. The lower interest rates produced in our country by the mercantilist trade manipulations finance our higher consumption and higher government budget deficits, not our investment. For example, the mercantilist-financed house price bubble from 1998 through 2006 financed the "consumption" of housing, not fixed investment in American production.

The solution, as my father, son, and I note in our 2008 book Trading Away Our Future, is to address the trade deficits and our savings rate at the same time. Balancing government budgets would indeed increase our savings rate, as would replacing the corporate income tax with a Value-Added Tax.

Bartlett thinks that reducing our government's budget deficits will reduce our trade deficits. He forgets that our trade deficits exploded even while President Clinton and the Republican Congress were moving our budgets into surplus in 1999 and 2000.

Moreover, balancing budgets without balancing trade right now would produce another recession, and the recession would again temporarily reduce our trade deficits. There is a much better solution: requiring balanced trade with the mercantilist countries, as permitted by WTO rules, while replacing the corporate income tax with a VAT.

Disclosure: I own Chinese yuan through CYB