Taxation, the States, and Trade

The State of Connecticut, and other states, are having increasing difficulty meeting the conflicting demands  of a declining tax base and increasing need for its services.  Next year the state must cut over $1 Billion of valuable and even critical services in order to balance its budget.

A recent article in Forbes ascribes the cause of the deteriorating tax base to the imposition of a personal income tax 25 years ago. (25 Years, $13 Billion Lost: Connecticut Income Tax Continues To Fail) *

But let’s look at something else which could be a cause:  According to “State Smart,” ** the state of Connecticut, in 2014, paid out  $53 Billion dollars to the United States government in taxes.  However, that year, it only received am estimated $45 billion in benefits from the federal government. Every year the people of the Connecticut give out to other states $8 billion.  The state and local share of that $8 Billion, (about 13%) works out to about $1 Billion in lost taxes.   And that is just one year.

It is up to the state’s Congressional delegation to address this problem, if they can.  In the meantime, the state is running the race with one foot in a bucket.  While bad, this can be mitigated.  The problem for the state, since it is easier for rich people, and more generally for businesses and corporations, to move than the working and the poor, is that the state is only allowed a regressive tax system. Since Connecticut is stuck in the shadow of pricey New York City, it must also pay more for what it buys.  These are not insurmountable problems.  They mean, however, that the state must attract enough wealth generating business activities that the tax load is not so burdensome upon the poor and the working class that it cannot be mitigated by proper state expenditures. And this means the state must have tax policies, and spending policies, and regulatory policies, which are attractive to those kinds of business activities which bring in money.

For instance, Corporations collect wealth from their many operations, and the place they accumulate the most of this wealth is at their headquarters. Other business activities which accumulate wealth are corporate offices in general, laboratories and factories.  All of these activities bring money into their communities, and into the state. 

These are activities the state wishes to attract and encourage.  While it cannot directly subsidize them, (Well, nominally, it could,)  it can capitalize the infrastructure these businesses rely upon.  Investing in roads and railroads, human capital, but perhaps even more importantly efficient institutions and the resolving of conflicts, including those inevitable conflicts businesses have with the state itself.   This will reduce the many costs of doing business in this or any state, and enhance the profit margins. 

For comparison, stores, in particular chain stores such as Walmart, Home Depot, CVS, McDonalds, (and Amazon) and so forth, take money out of communities, and out of the state.  Walmart itself takes several billions of dollars out of the state of Connecticut each year, and sends those dollars off to Arkansas. Much of the money which goes to the larger cable and telecommunications also leaves the state. This loss of money the state can, with proper taxes, and by taking the part of the communities and local store owners in their struggle with these large retail chains, diminish. 

There are other activities, which themselves do not generate wealth, but merely rearrange the ownership of wealth.  These may also be taxed.  Some of these businesses, like real estate, cannot leave.  The others, since they do not actually generate wealth, may be allowed to leave without penalty to the state’s economy.  These would include many personal services of all kinds.  Most of these personal services are elective, and raising their costs would not affect the well being of most people directly.  Most especially, these taxes would not have a critical affect on the well being of the poor.  For those services which were not elective, such as child care, the needs of the poor could be supported.  Indeed, for something like child care, the state would in general have and interest in subsidizing it for all possible clients, as this would form a more attractive workforce environment and this would be something to attract businesses.

The state is in the business of allocating resources.  Taxes take those resources from one use and expenditures put them to another.  In many cases, this fulfills social needs that the market cannot fill.  Quite simply, the market simply cannot supply any particular thing or service to everybody.  The laws of supply and demand guarantee that there will always be those who cannot afford fuel, who cannot afford shelter, who cannot afford adequate food, without intervention into the marketplace.  Private intervention, that is, charity, cannot suffice. For the charitable will find themselves at a competitive disadvantage to the mean and selfish.

As the production of resources within the state declines, the state must reach out to the production of other states, by attracting the functions of businesses which accumulate the production from other states.  And the state government must adopt policies which attract those functions.  It is only once this income is spent by the corporations and businesses that the state attracts, that the state can begin to collect taxes on it. And increasingly, the state becomes unable to directly tax its own production.  As due to increasing offshoring, domestic production declines, (And without tariffs, taxes cannot be collected on production in foreign countries,) competition for the remaining factories, other remaining production facilities and the headquarters of domestic enterprises, the offices and laboratories, will intensify. Only the intervention of the US government can stop this spiral to the bottom.  But in the absence of such intervention, a state government which understands this reality, and which is able to adapt to it will, for a time, prosper.

So only the actions of a government can assure that the needs of all of society are met. A government which fails in this, will eventually fail altogether, one piece at a time, as first the bottom, and then each higher level of society falls below its ability to sustain itself.  Only by capturing an adequate share of the incomes of the very wealthy can the government succeed at this. But first it must attract these incomes to itself. 

Since all taxation is against production, the government must capture all productive streams, in order to extract necessary income. Any streams it does not capture will be more competitive than those which must bear the additional cost of taxation.  When an economy runs a trade deficit, it must also tax foreign production, since otherwise domestic production will be uncompetitive with foreign production, and domestic production will be replaced, and government revenues decline.

Non-productive activities must also be taxed. Otherwise, economic activity will preferentially go to non-productive activities, since these will have the greater nominal profits.  In particular, the non-productive activities of the wealthy must be taxed, to prevent decapitalization of the economy.

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* http://www.forbes.com/sites/rexsinquefield/2016/05/23/25-years-13-billion-lost-connecticut-income-tax-continues-to-fail/#589c29771b80  (and others)

**https://www.nationalpriorities.org/smart/connecticut/

Education is Insufficient to Maintain US Wages with Unrestricted Trade

A recent post over at Bloomberg Business:' Global Labor Glut Sinking Wages Means U.S. Needs to Get Schooled'  http://www.bloomberg.com/news/articles/2015-05-04/global-labor-glut-sinking-wages-means-u-s-needs-to-get-schooled is nonsense.

Education will not maintain US wages in the face of international competition. Once foreign countries are able to supply sufficient basic education, both in quantity and quality, there is nothing to stop them investing in the necessary specialized education needed for their own workers. Information (education) is more transferable than labor. The US cannot embargo the export of information.  The development of skills in foreign countries cannot be prevented. Any advantage in education is transitory, requiring a continuing race of investment in human capital. Further, the cost of education in US is greater than the cost of the same education in foreign countries, the US is at an absolute disadvantage in such a race.  Because education in the US is more expensive, it makes greater sense for international corporations to invest in the education of the foreign workers, rather than American workers.  Finally, the high cost of maintaining and developing capital in the US discourages the investment in education in the US, aggravating the competitive disadvantage in which American labor finds itself. 

In particular, the equalization of factor prices affects those factors more directly exposed to international competition faster than those factors more insulated from direct competition.  (All factors of production are connected, and therefore affected. The price of all factors of production eventually equalize, across borders. However, during the transition stage to the new equilibrium, the relationship of factor prices within the economy is altered.)   In the American case,  because of its substantial trade deficit with low wage so called ‘developing nations,’ the prices of labor and other exposed factors declines faster, while factors such as education and government, (in particular infrastructure, and military,) become relatively more expensive, and more difficult for the rest of the economy to sustain.  On the other hand, in the case of the developing countries themselves, and where they run a substantial surplus, these insulated factors become relatively less expensive, as the prices of the exposed factors rise faster.  Education, (and infrastructure, and the military,) in the developing countries thus becomes relatively inexpensive to capitalize.  Thus, the US is also at a comparative disadvantage in providing education to labor. 

One further aspect is that because the price of American education is increased relative to the rewards, and a greater share of that cost is borne by the individual, the individual is less encouraged to capitalize in himself.  This is aggravated by the fact that, with continued economic destruction because of the deficit, and inequality and resultant decrease in career opportunities, vs mere job opportunities, the chances of advancement through education are reduced anyway, especially for disadvantaged youth.  Indeed, many of these might see the costs, in time and attention, of even a minimal education as not worth the bare rewards this society seems to them to be prepared to offer them.

 The result of these factors is that, over time, US labor's disadvantage will increase, and their wages continue to decline.  This decline in wages will not result in greater competitiveness, because the capitalization of the American labor force will be reduced over the period of factor equalization, and be less than the capitalization of their foreign competitors.

Efforts to educate the American work force will not save American jobs or maintain American wages in the face of international competition.  These efforts are not being made, anyway.

Corrected and slightly expanded version of an earlier post

Education is Insufficient to Maintain US Wages

EDIT:  Improved version at: http://anamecon.blogspot.com/2015/07/education-is-insufficient-to-maintain.html


A recent post over at Bloomberg Business:' Global Labor Glut Sinking Wages Means U.S. Needs to Get Schooled'  http://www.bloomberg.com/news/articles/2015-05-04/global-labor-glut-sinking-wages-means-u-s-needs-to-get-schooled is nonsense.

From the post: "The most effective way of combating this oversupply [of workers] is to promote increased training and education of U.S. workers so they can provide skills unavailable elsewhere to employers, according to experts who have studied the problem."

Education will not maintain US wages in the face of international competition. Once foreign countries are able to supply sufficient basic education, both in quantity and quality,  there is nothing to stop them investing in the necessary specialized education needed for their own workers... Information (education) is more transferable than labor. .The development of skills in foreign countries cannot be prevented. The US cannot embargo the export of information..Any advantage in education is transitory, requiring a continuing race of investment in human capital.. Further, since the cost of education in US is greater than the cost of the same education in foreign countries, the US is at a disadvantage in such a race. For example, it is economically efficient for foreign countries to import US educators to train their own work force. For the same pay as in US, foreign nations can often supply a much. higher standard of living. And because education in the US is more expensive, it makes greater sense for international corporations to invest in the education of the foreign workers, rather than  American workers.... Finally, the high cost of maintaining and developing capital discourages the investment in education in the US, aggravating the competitive disadvantage in which American labor finds itself. The result of this is that, over time, US labor's disadvantage will increase, and their wages continue to decline.  This decline in wages will not result in greater competitiveness, because of the decrease in the capitalization.of American labor force.

Destruction of Production from Unbalanced Trade

Walmart promises lower prices.  But at what cost to society?  Locally, the consumer seems to benefit.  But what about the domestic producer, who may be put out of business when a foreign supplier is chosen over him?  He is also a consumer.

We further discuss the situation of unbalanced trade, where one country runs a trade deficit with another country.  For previous discussions, see:   http://anamecon.blogspot.com/2011/03/free-trade-welfare-and-debt.html  and the pointer there.

We start with a retail outlet, which sells the product of a domestic producer.  The domestic producer (or it may be many producers)  produces quantity  Q of his product at price P, at the equilibrium point e, intersection of the supply S and demand D curves (blue and red dashed curves.)  The quantity Q goods sell at price P for total revenue to the producer, or producers, of P x Q.  This is also the price paid by the total of all consumers.

 A foreign producer produces at price P’ less than P. If the domestic producer cannot produce at P’, the retailer chooses the foreign producer.  The supply curve shifts down by the difference between the prices, P – P’, in the diagram to the solid S curve, and the new equilibrium point is at e’.  This would be an improvement for the consumer. He would get more goods, at a lower price. However, this is not the whole story, because the domestic producer is also a consumer.  The consumer is also a producer.  The revenue which formerly went to the domestic producer, P x Q, is lost to the domestic market. The new amount of revenue, P’ x Q’, the size of the market at e’, goes overseas, to the foreign producer.  Or would if e’ was the new equilibrium point.

 

But it is not, because the domestic producer, no longer in the market, shuts down, and the demand is shifted down by P' because of the loss of revenue to the domestic producer. (The reduction in demand is going to be the area between the two demand curves. This is equal to the money lost to the overseas producer.)  This revenue the domestic producer no longer has to consume with. 

Thus the new equilibrium point is really at e”, the new intersection of the shifted demand and supply curves.
So whether or not the the new equilibrium point e” is to the left or right of the original equilibrium point is going to depend on the relative elasticities of the supply and demand curves, and the relative difference in the size of the shift of those curves.If the demand is inelastic and the price for imports is sufficiently lower, ( a decrease to something less than 50% of the domestic price of production,) the increase in consumer welfare in the domestic market could be comparable to and even greater than the loss in domestic revenue. So the domestic economy might even show a benefit. 

In general, if we just compute the gain in consumer welfare to the loss or producer welfare, there will generally be some gain. However, this neglects the loss in producer welfare to producers of factors higher up the production chain. The costs to a producer are always revenues to the producers of factors to that producer, and these other producers will also suffer  Whether this chain of suffering amplifies or diminishes as it propagates would seem to require a closer analysis of the different cases..

With balanced trade, there is an increase in welfare for everybody. Producers get to produce more.  Consumers get to consume more. However, that increase also includes an increase in marginal production and marginal consumption. The possibility remains that the increase in benefits is at a cost in resources which would be more efficiently used elsewhere in the trading countries, the cases generally being those with inelastic supply and elastic demand.

EDIT: Diagram and discussion corrected 05-20-2019 .

Price goes down, but income goes down further, since money goes overseas, following foreign suppliers, and does not come back to consumers, except perhaps as a loan.  But money continuously goes overseas, and does not come back.    

The true equilibrium point is at quantity Q* = 0.  That is, without balanced reciprocal trade, the equilibrium is at zero imports. It may take a long time to get there, but the net final result is merely the destruction of domestic production. The economy is no longer able to import except by selling off capital. But in this it is limited, also. There is only so much capital.  There does exist, however, the argument from debt:  The economy can be maintained by borrowing.  But this is in the long term untenable, and any net import must eventually be paid for by destruction of future production.  Further, because of the costs of borrowing, the amount of future productive capacity destroyed is greater than would be destroyed without borrowing.  Borrowing makes a bad situation worse.   

Let’s take a different look at the change in situation.  Consider first the domestic economy as a closed system. The flows of  money (Black) and goods (Red) stay within the domestic boundaries, and the system is in equilibrium, by which we mean that roughly the flows compensate for each other.  (The rest of the economy consists of other producers and consumers.)  There may be changes, but these are accompanied by corresponding changes in other flows.

If, however we introduce unbalanced trade, money is exported to the foreign economy and goods are imported from the foreign economy.  Since there is no flow of money into the domestic producer, the domestic producer closes down. As a result, all flows of goods and services to and from the domestic producer close down. 

We observe, like water through the drain in a sink, money continuously flows out of the domestic economy.  Goods flow in, but unless the goods are capital goods, (and they would likely not be, because the return on investment is lower in the country running the deficit,) they are consumed and need to be continually replenished.  The continual loss of money represents ever increasing demand (money is demand) by the foreign economy on the domestic economy, while the domestic producer has been eliminated.  The domestic economy is thus ever less able to pay an increasing debt. It is certainly less able to repay with production. But it is also increasingly unable to repay this debt even with capital, because the value of capital has decreased, since its return is lower due to the foreign competition.

For comparison, we draw the same diagram with balanced trade, where the domestic producer has found a foreign buyer for his production.  Note that, while the domestic economy is here balanced, the upper foreign economy in the diagram runs a deficit wrt the domestic economy, and the lower foreign economy in the diagram runs a surplus wrt the domestic economy.  In the long run, these tendencies would have to be compensated for, by trade between the two foreign countries, just as they would have to be compensated for in the domestic economy. 

So, what would be the effects of a trade deficit on the domestic economy.  We already know that the domestic producer shuts down, resulting in a shift downward in the demand curve greater than the downward shift in the supply curve.  Since the new equilibrium point e” is to the left of the original equilibrium point e, the quantity supplied at Q” is less than the original quantity supplied at Q. However, the same phenomenon happens for all imported goods. All imported goods are supplied at lower quantities than were originally produced by domestic producers.  Otherwise the domestically produced good would be preferred by domestic consumers.

On the level of the individual, the mean income decreases, and is greater than the decrease in price.  That is, in real terms, the average consumer is poorer, because of the trade deficit, than he was before there was a deficit. The decrease in price does him no good, because the decrease in his income is greater. From a social point of view, poverty increases, and income and (long term) spending of the average individual decreases.  From an economic point of view, capital investment decreases, and indeed, on average, the economy is decapitalized, that is, its capacity for production decreases.  This has the implication that the costs of capitalization increase.  Another way of putting this is that the return on investment decreases.  The economy is less able to maintain itself and its infrastructure can be expected to be under maintained, and to decline.

The results of running a trade deficit demonstrate the need for government regulation of trade. Clearly, a private entity may increase his profit while destroying a part of the domestic economy, if it is not compensated for. The free market credo would be that this is just too bad for the domestic producer.  This should be discouraged, because the damage is not restricted to the domestic producer.

It also shows some of the consequences of incompetent, or if it be, treasonous, government, allowing or even encouraging the destruction of the livelihood of many of its citizens.

Finally, it shows that it is sometimes necessary to think two steps, instead of only one, in reaching conclusions.