In the past week, I have been in the car coming home late from work, with the
presidential debates are on the radio. It is very discouraging to listen to what passes for
economic literacy among the candidates. In reality, many candidates are espousing
policies that are quite dangerous at worst, or simply misleading at best. Far too many in
both parties tell a frustrated America what it wants to hear, rather than the economic
reality.

The Republicans have some of the worst offenders.
So, today we will look at some economic reality. We tackle trade deficits, the
dollar, taxes (the “Fair Tax”), how should we stimulate the economy as we slip into
recession, and global trade. I think we will cover enough that I can just about guarantee to
offend most of my readers at some point. But the main point I want you to take away
from all this is that the simple one-line answers given at these debates might work to fool
most of the voters and tell them what they want to hear, but they are not based in
economic reality. While this is of more interest to US citizens, the principles apply across
borders. So, let’s jump right in.

The trade deficit jumped this month by almost 10%, to $63 billion. To hear the
candidates talk, we can lower the deficit by forcing China to allow its currency to rise,
increase our exports because of a lower dollar, stop our dependence on high-priced
foreign oil, etc. Whatever the problems are, they are not of our making.
Let’s look at the reality. I asked my friends at Plexus to create a few charts for
me.

First, let’s see if a lower dollar will have a major impact on the deficit. The deficit is
in red, and the numbers for the dollar index are on the right. Notice that from 1992 until
2002 the dollar got stronger and the trade deficit rose. Of course, there was the period
from the end of ’93 until ’95 where the dollar dropped almost 20% and had seemingly
very little effect on the trade deficit.

Now notice that from 2002 until the present the dollar has gone down and the
trade deficit has exploded. If a weaker dollar were the answer, then one would expect the
trade deficit to improve. Yet, the deficit has roughly doubled since 2002 while the dollar
has dropped by more than a third. Using a trade-weighted dollar index would produce the
same visual results, although the trade-weighted dollar has dropped by “only” 25%.

As I have maintained for years, I expect the Chinese to allow their currency to rise
slowly. By the time the next president can have a foreign policy team in place to focus on
the issue, the Chinese will have allowed the yuan to rise another 15% or so. This will
bring it very close to the 30% increase in valuation that the China hawks in Congress
have been wanting.
The reality will be that the Chinese will have done almost all the
heavy lifting within 18 months.

What will be the result? It means that the $325 billion in goods and services that
we buy from China will cost us 10-15% more than it does now. Will we buy 15% less?
Not if that is how we want to spend our money. And that brings us to the next chart.
While there is not an exact correlation, the trade deficit rises as consumer spending rises,
which makes sense if you think about it.

No, the simple answer is that the trade deficit is not going to come down until the
US starts to save more and spend less. In 1992, consumer spending was a little over 65%
of GDP. It is now closer to 72%.
Savings are down from 8% in that time, to barely above

The only candidate I will specifically mention is Mike Huckabee. His espousal of
the Fair Tax demonstrates his lack of understanding of reality and economics. Basically,
Fair Tax proponents want a 23% sales tax to replace every type of government tax. No
more income, corporate, social security, or Medicare taxes. And everyone gets a $5,000
or so “prebate” which covers the taxes up to the poverty level. What could be simpler or
more fair?
No one would like to get rid of the IRS more than I. I spend way too much on
accounting for taxes and such. But this is not the way to do it.
First of all, the 23% they talk about is really 30%. Under the proposal, if an item
sells for $100, then $23 of that would go to the government (said to be tax-inclusive).
That means the item really costs $77 and the tax is an additional $23 or about 30% (said
to be the tax-exclusive rate). Add an average 7% for state sales tax and we are now up to
37%. But wait, it gets worse.

That 23% number simply won’t produce the revenues they suggest. That assumes
the government will pay the tax, so the budget has to go up. It also assumes that there is
100% compliance and everyone pays that 37% (yeah, right – just like they do the income
tax).
Bruce Bartlett writes this week in the

“A 2000 estimate by Congress's Joint Committee on Taxation found the taxinclusive
rate would have to be 36% and the tax-exclusive rate would be 57%. In 2005,
the U.S. Treasury Department calculated that a tax-exclusive rate of 34% would be
needed just to replace the income tax, leaving the payroll tax in place. But if evasion were
high then the rate might have to rise to 49%. If the Fair Tax were only able to cover the
limited sales tax base of a typical state, then a rate of 64% would be required (89% with
high evasion).”

44 states have income taxes. They would have to repeal their income taxes and
raise their sales taxes in order for individuals not to have to file annual income tax returns.

Do you really want to add 30% to the cost of a new home? And pay an extra 30% in interest on the borrowing price? 30-40% more for your legal services? Do you want your rents to go up 30%? Do you really think that massive evasion would not follow? We would move back to a black market cash economy so fast it would take all of Ben
Bernanke’s printing presses working overtime to create enough cash for the black market
economy.

Yes, in theory it would mean that exports would be priced more competitively, as
corporate taxes are removed. The idea as theory is not entirely without merit, but every
independent study I have read suggests the number for the tax when combined with state
taxes would be north of 40% and maybe more like 50%.
Further, this is a tax hike on the middle class. If you make less than $15,000 you
win. If you make more than $200,000 you win, because you actually save more and
spend less of your income. This is a nice populist proposal which sounds good but is
economically challenged. It only works on someone who has not read about the
problems.
Let me give you two links if you want to read more. One is to Bartlett’s article
and the other is to the people at Fact Check (a very good site for lots of facts on a lot of
things)

The call by Huckabee and others to deport 12,000,000 illegal immigrants is
simply economic suicide. It would create a depression (not just a minor recession) in
short order. Let’s reduce productivity by 10-15%. Let’s reduce consumer spending by 7-
8%. Shut down hundreds of thousands of businesses who could not get workers they
need. Who will pick the crops? Or do any of a hundred jobs that Americans don’t want to
do? It would drive up labor costs and create inflation. It would be a disaster of Biblical
proportions.
Now, I am all for controlling the border. I want to know who is coming in. But we
have to deal with reality, and the reality is that we need those workers who are here. The
economy simply will not function without them. You can’t send them home and then tell
them to apply and hope they can get back in, and then expect business to function as
usual. It will take years for a bureaucracy to handle the paperwork.
Go ahead. Close the borders. Find out who is here illegally and make sure they do
not have a criminal record. If so, they go. The rest need to get documented, and we need

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to radically increase the number of immigrants we allow (after we control the borders!),
especially educated workers who can help us build our knowledge economy.
And yes, this is amnesty. That is the cost of not controlling the border all these
years. Nothing we can do about it, unless we want to shoot ourselves in both feet just to
prove a point. Sounds rather dumb to me.
The great irony is that within ten years we are going to need even more
immigrants to replace retiring boomers, as well as to pay into social security and
Medicare programs. We are going to be competing with Europe for those immigrants.
We need to get a head start.
And yes, it is a lot more complex than this quick analysis. But pandering to voters
who for whatever reason want to stop illegal immigration by throwing out everyone who
is here illegally is not the answer. Establish fines, require documents, whatever. But
recognize reality and stop telling voters what they want to hear when your policies simply
cannot work and will be destructive.

In the Republican debate in South Carolina last night, the candidates were asked
what they would do to stimulate the economy if it is rolling into recession. Nearly every
candidate said “I would cut spending” as an answer.
I guess they skipped that class in Economics 101. Deficit spending is a stimulus in
the short term. Cutting spending in the short term would be the opposite. I am a huge
proponent of cutting spending, smaller government, balanced budgets, etc. But you don’t
stimulate an economy that is rolling into recession by cutting spending. Dumb answer,
and those who are doing the questioning should call them on their economic garbage.

The Democratic candidates agree that the Bush tax cuts needs to be repealed. So,
in 2010 we face the largest tax increase in history if that is to be the case. Want to double
the dividend and capital gain taxes? Vote for Hillary or Obama. Watch your stocks tank.
They want to “tax the rich” and make more for middle class tax cuts. Sounds nice,
but let’s look at the facts. The bottom half of taxpayers only pay 3% of the total income
taxes collected, which is 1% less than before the Bush tax cuts. 44% of the US
population, or 122 million people, pays no income tax at all.
The richest 1% of the country pay 39% of all taxes ($365,000 income and up),
which is 3% more than before the Bush tax cuts, under the Clinton tax policy. The top
5% ($145,000) pay 60% of all taxes (up 5% from 1999); and the top 25%, with income
over $62,000, pays paid 86% of all taxes. It seems to me that the rich are paying their fair
share. Every category is paying more now than under Clinton, except the bottom 75%.

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Under any Democratic plan, they would want more than 50% of US citizens to
pay no income taxes. If you pay no taxes, why do you care if we run deficits? Polls
clearly show that those who pay no taxes are overwhelmingly against tax cuts, as they
think it will cut their entitlements and benefits. The plan is clearly to build a constituency
of voters who will vote Democrat to increase taxes on someone else and spend the money
on programs for them.
Any increase in taxes at the levels proposed by Democrats is by definition antigrowth.
Government spending is not as efficient or productive as private spending. It will
also be a large drag on the stock market. 2010 is now less than two years away. Congress
is going to have to deal with tax policy in 2009 or risk a major economic setback. See
how safe your job or business will be in a second recession within a few years, like we
saw in 1980-82.
A repeal of the Bush tax cuts would raise taxes on the bottom 75% of the country,
and cut taxes for the rich, as a percentage of total taxes paid.
I can go on, but I have probably offended enough readers for one weekend.