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"No New Taxes"

Written by Briton Ryle
Posted March 6, 2017 at 7:14PM

"Read my lips: No New Taxes." 

It was August 18, 1988. The phrase was spoken as George Herbert Walker Bush accepted the Republican nomination for president. People don't like to recall the fact that the previous administration, two terms of Ronald Regan, wasn't exactly the "cut taxes, get growth" paradise for which it is longingly remembered. 

Yes, income tax rates were cut under Reagan. The top bracket went from 70% to 28%. The standard deduction was indexed to inflation. Some business deductions were made more generous. 

And if you simply look at government tax revenue, which essentially stayed at the 40-year average, you might think that the Laffer curve actually worked...

For those who don't recall, the Laffer curve was the name given to a theory put forth by economist Arthur Laffer that postulates that you can raise tax revenue by strategically cutting taxes because the tax cuts will spur higher growth rates. Higher growth will, in turn, mean more tax revenue simply due to increased activity. 

It sounds pretty good. But it's also a fantasy. Which is to say, it hasn't been proven. 

Because even though Reagan cut income taxes and still maintained tax revenue at previous levels, that's not the only thing that happened. Taxes went up on some asset sales. Some pension benefits were reduced. Some tax breaks were cut. Payroll taxes rose...

But more importantly, government spending rose a lot. As a percent of GDP, the 40-year average of government spending had been 20.7%. Under Reagan, it jumped to 22.4%. Increases in spending go hand in hand with an increase in growth. Combine that with some offsetting tax hikes, and you just can't say that it was tax cuts alone that pushed growth during the Reagan years. 

Debt and Growth

You can justify an increase in spending when growth picks up. And you can justify tax cuts when they are offset by growth. But when you cut taxes and increase both growth and spending, there's one place to look to see if it's all working as planned: debt. 

Reagan's first term saw a budget deficit of 2.6% of GDP. By 1983, the budget deficit ran a full 6% of GDP. And it stayed around 5% through 1987. So while it's fine to argue that tax cuts may have helped growth, it must be acknowledged that an increase in spending helped, too. And you especially can't credit tax cuts for growth when you have other tax policy that's offsetting those cuts. 

People were well aware that some taxes had been increased and other tax benefits had been cut. So, that's the backdrop against which George H.W. Bush made his famous "no new taxes" pledge. Unfortunately, amid the rising budget deficits and the recession of 1990, Bush had a choice to make: enact cuts in defense and entitlements, or raise taxes. 

One of the tax hikes was a luxury tax, on yachts and expensive cars. It was enough to put the lie to his "no new taxes," and he lost his re-election bid to Bill Clinton. 

These days, the emphasis on "no new taxes" remains strong. And we have an administration that has promised tax cuts for individuals and corporations alike. And in fact, much of the stock market rally we've enjoyed is directly due to the promise of a corporate tax cut. Cut the corporate rate from 35% to 25%, and the companies will immediately earn an extra $10 in annual per-share earnings. 

Of course, what could have been an easy win for this administration — a corporate tax cut — has been moved to the back burner. And a much more problematic new tax has been moved to the front burner...

The Border Adjustment Tax

Perhaps the biggest promise President Trump made during his campaign was that he would bring manufacturing jobs back to the United States.

It's understandable why this promise has resonated. It has been a constant theme over the last 10+ years that companies have offshored their manufacturing overseas. Never mind that U.S. manufacturing is producing more goods than it ever has. And never mind that foreign manufacturers like Mercedes and BMW have plants here in the States. When you see Ford cars coming from Mexico, it strikes a chord with voters. 

The Trump administration has adopted a few strategies to fulfill its promise of bringing jobs back. One of them has been to publicly shame companies that move manufacturing offshore. Carrier and Ford are two that were called out by Trump and actually decided to make a change. Or at least a partial change: Ford said it would abandon one plan to move a plant to Mexico, but another plant in Mexico will go operational as planned. 

I'll admit, I'm surprised that Trump's public shaming actually worked, to an extent. And I wonder, if it were that easy, why has no president tried that before? Trump definitely deserves some praise for this. 

But I don't think the ideas for a border adjustment tax are going to work as well. 

The official definition of a border adjustment tax is: a value added tax levied on imported goods. It is also called a border-adjusted tax, border tax adjustment, or destination tax. Exported goods are exempt from tax; imported goods sold domestically are subject to the tax.

Basically, if a U.S. company makes a car in Mexico using non-American parts, that car will be taxed when it comes into the U.S. for sale.

Clearly, this border adjustment tax is intended to make it more expensive for U.S. companies to have production overseas. Ideally, the tax would offset any gains from cheaper foreign labor, so why not just build it here? 

Two problems: One, there's no way foreign countries will just accept this. They will retaliate. And then we have trade wars that will be bad for the economy and for jobs. You can talk about making America great again all you want; provoking a trade war won't do it. 

And two, think about the industries that a border adjustment tax would impact. Think retail...

We basically don't make sneakers in the U.S. We never have. All of them are imported. You add a border adjustment tax, and you will pay more for those Nikes...

Fact is, the cost of living in the U.S. ranks 25th. For the world's most advanced economy, it's a testament to our economy that it's more expensive to live in 25 other countries. And if you look at just clothing and footwear, our costs rank 50th in the world. Again, add the border adjustment tax, and those ranking change...

A tax is always a tax. And it will ultimately be levied on you, the U.S. taxpayer. Retail margins are razor thin: if they pay more, you pay more. 

This is known as a zero-sum game. To bring manufacturing back to the U.S. means each of us will pay more for goods. 

When it comes a border adjustment tax, I want us to defer to George H.W. Bush's pledge: "no new taxes."

Until next time,

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Briton Ryle

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An 18-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He also contributes a weekly column to the Wealth Daily e-letter. To learn more about Briton, click here.

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