Taxes, trade and GDP

Noah Smith has a good post on a topic that’s getting a lot of attention in the blogosphere.  It seems that the recently enacted tax reform is likely to dramatically boost reported exports, without (necessarily) impacting actual exports at all:

Here’s an example adapted from Guvenen et al.’s paper. Suppose that NoahCorp produces the NoahPhone, using research, design and branding done in the U.S., then sells it to people in Japan. Normally, the revenue from that sale would be counted in U.S. exports. But in order to avoid paying corporate tax on the profits from the sale, NoahCorp sells its patents and brands to NoahCorp Ireland for a pittance. It then declares that the profit from the Japanese phone sale actually goes to the Ireland subsidiary, not the U.S. parent company. The parent then doesn’t have to pay U.S. corporate tax. And the phone sale doesn’t get counted in U.S. exports. . . .

The result of all this profit-shifting is that the U.S. trade deficit seems wider than it really is, while U.S. income on foreign investments gets overstated. It looks like the U.S. is really bad at selling things overseas, but very good at choosing its foreign investments. For many years, pundits believed that wise U.S. investing was partially making up for uncompetitive manufacturing — now, it turns out that both of those stories might be different aspects of the same illusion.

With the new and lower corporate tax rate, companies will now be willing to declare this revenue as income from US exports.  And that could have political implications for an administration that is all about smoke and mirrors and marketing:

Nothing real will be changing, of course. The same phones will still be sold, and the same intellectual property will be created. But it will look like a huge win for the Donald Trump administration, which pledged to cut trade deficits.

I’m a bit skeptical that this will work.  Unless I’m mistaken, any gain in the trade account will be offset by deterioration in the services account as investment income declines, leaving the current account unaffected.  (Someone tell me if I’ve made a mistake here.)  And it’s the current account that pundits focus on, not the trade account.

On the other hand, this would tend to boost reported GDP, without boosting actual GDP.  It will be interesting to see how large the effect will be, and how durable.  My hunch is that any boost to growth would be modest (below 1%) and temporary.

I don’t worry at all about the President taking credit for things that are not real, as the public sees through the phony data.  When Trump took office he claimed the the unemployment rate almost immediately fell from the 30% to 40% range, down to about 4.1%.  But nobody took this seriously.  (Ditto for his recent claim to have repealed Obamacare).  Trump has made so many absurd claims that even his supporters don’t take anything he says seriously.  All that matters in 2020 is how the American people feel they are doing, not what the data show.

HT:  David Levey



18 Responses to “Taxes, trade and GDP”

  1. Gravatar of Effem Effem
    22. December 2017 at 08:28

    So in an NGDP-targeting world we would have just had a sizeable jump due to the tax bill and thus tighter money?

  2. Gravatar of Scott Sumner Scott Sumner
    22. December 2017 at 10:06

    Effem, Good point, although I doubt in this case the effect will be that large. But there is the potential of it being large. In that case the Fed might want to adjust the NGDP target to offset the distortion caused by the tax change.

  3. Gravatar of Lorenzo from Oz Lorenzo from Oz
    22. December 2017 at 14:56

    Off topic, but central banks stabilising nominal spending being presented as clearly the best (even almost obvious) policy.

    Winning the argument one economist at a time …

  4. Gravatar of Gordon Gordon
    22. December 2017 at 15:29

    >And it’s the current account that pundits focus on, not the trade account.

    Scott, almost all of the news articles that I’ve seen focus on the trade account. I’ve seen the current account mentioned once. And the financial reporter of the article said the current account was something about which only economists care. It was clear he couldn’t bother to do a tiny bit of research to find out what it was and why it mattered.

  5. Gravatar of B Cole B Cole
    22. December 2017 at 16:10

    Egads. Between clever accountants and tax lawyers, an incomprehensible tax code. offshore banking and curiously placed HQs and profits…who knows what?

    This is “tax reform”?

    In the modern world, income taxes can be outmaneuvered. Time to go to sales taxes, property taxes, pollution taxes, and tariffs on imports.

    BTW, I guess it’s clearly understood by everyone in the establishment that there needs to be no reduction in payroll taxes.

  6. Gravatar of Scott Sumner Scott Sumner
    22. December 2017 at 16:25

    Gordon, Maybe we read different media.

  7. Gravatar of Scott Sumner Scott Sumner
    22. December 2017 at 16:26

    Thanks Lorenzo.

  8. Gravatar of dtoh dtoh
    22. December 2017 at 16:26


    You said, “With the new and lower corporate tax rate, companies will now be willing to declare this revenue as income from US exports.”

    I don’t think this is the case. If you read the Goldman Sachs paper on which Noah’s post is based, you will see that almost all of the shifting (of reported income) is to very low tax rate countries. Because the cost of setting up and managing paper entities in these tax haven jurisdictions is de minimis, there is a positive benefit to continue tax shifting as long as U.S. tax rates remain higher than the rates in the tax haven jurisdictions, which is in fact the case even with U.S. rates reduced to 21%. Tax shifting is done primarily by large MNEs (multi-national enterprises) who have very sophisticated and efficient cash and tax management operations. If there is a penny to be saved, it will be saved. In other words, there is a step function (or very close to a step function.) As long as US rates are still higher than tax haven countries there will be no shift in reporting back to the U.S.

  9. Gravatar of Scott Sumner Scott Sumner
    22. December 2017 at 16:34

    dtoh, That sounds plausible, but I don’t know enough to comment. So I relied on what I read. In any case, we’ll know fairly soon, just as we’ll soon know the effect of the tax changes on the US housing market.

    But didn’t one study find a similar effect in foreign countries that adjusted their corporate tax rates?

  10. Gravatar of dtoh dtoh
    22. December 2017 at 18:48


    So I think you will see some shift (albeit with a not insubstantial time lag) of real activities to the U.S., but you won’t see much paper shifting of profits from Irish subsidiaries to Delaware subsidiaries.

    IMHO, the impact of the tax will be primarily through higher fixed investment leading to higher productivity and output. Sure some of the tax cuts will get distributed to higher executive comp, higher wages to employees, lower prices to consumers that lead to higher consumption rather higher investment, but IMHO most of the tax cut is going to go into increased investment and a lot of the investment will get leveraged with debt so there’s a multiplier effect.

    BTW – The original Goldman paper was pretty well done, but Noah jumped to some conclusions that were not at all supported by what was in the paper.

  11. Gravatar of E. Harding E. Harding
    22. December 2017 at 23:42

    “When Trump took office he claimed the the unemployment rate almost immediately fell from the 30% to 40% range, down to about 4.1%.”
    This didn’t happen; Trump does still say in informal remarks the unemployment rate makes things look better than they really are.

  12. Gravatar of Matthew Waters Matthew Waters
    23. December 2017 at 07:50

    Generally, the false “arms-length” pricing has offsetting entries in the trade and capital accounts. NoahCorp Ireland will have buy intangible property at a lower price than its true market value. Then it would sell overseas or to its US parent at actual market values for phones. The overseas sales are exports which should be counted but are not. Sales to US are counted as important when they shouldn’t be.

    The profits will generally be in American bank accounts or investments, alongside their American profits. Apple has all its profits, foreign and domestic, invested through a small company in Reno, NV. These accounts create an offsetting capital entry.

    If profits were accounted as US origin, then both trade and capital accounts would have deficit/surplus respectively decrease.

    The new tax bill moves to a territorial system, which should have MORE incentive to put profits offshore. I had heard 20% tax on US profits and 10% on foreign profits. Unlike the old tax system, the 10% profits can pay dividends right away. So it is permanent savings. The tax bill does have measures to prevent gaming, but I haven’t found good details on it.

  13. Gravatar of Doug M Doug M
    23. December 2017 at 18:07

    Isn’t this exactly what “tax reform” supposed to do?

    With the highest corporate tax rate in the world, it was creating an incentive to manipulate the accounting such that as much a possible profits were generated by the overseas subsidiary. And now this incentive has been lessened.

    Any artificial distortions were a by-product of the old tax code. Even if nothing “real” changes and the only changes are accounting changes, this is still a good thing.

  14. Gravatar of ssumner ssumner
    23. December 2017 at 22:00

    dtoh, As I said, we’ll find out relatively soon.

    Harding, OK, his spokesman said the rate is now 4.1%. Does the press secretary speak for the President?

  15. Gravatar of E. Harding E. Harding
    24. December 2017 at 10:55

    Yeah; you’re right, Sumner, he does sometimes say the statistics make things seem better than they actually are, but not always.

  16. Gravatar of Scott Freelander Scott Freelander
    24. December 2017 at 11:19

    As lots of economists have said about Trump policies, they might ultimately yield .3% more annual growth, temporarily. This is Scott, Goldman Sachs, etc. Seems reasonable.

    Is that worth all the chaos, stupidity, assaults on truth and government credibility, foreign policy setbacks, etc.? Only a total fool would think so.

    And don’t bring up judge nominations. Any Republican chosen would have nominated conservative, pro-life judges. Many of Trump’s judicial nominees have had to withdraw their nominations, because Trump is too stupid to hire a team that can vet and choose qualified nominees.

  17. Gravatar of B Cole B Cole
    24. December 2017 at 16:21

    A nation’s GDP can be higher than GNI, especially if domestic assets are owned offshore. The income flows offshore. Krugman n has been blogging about this.

    Imagine an island nation, all assets owned offshore, 100 widgets produced a year and a 60/40 split of revenue labor to capital.
    In this example the island GDP is 100 but GNI is 60.

  18. Gravatar of bill bill
    24. December 2017 at 16:42

    I think this tax bill will give us another chance to see monetary offset in action.

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