Trump adviser's take on taxes, trade turns economic theory on its head

Yesterday’s presentation by Donald Trump's economic adviser, Peter Navarro, at the Tax Policy Center’s discussion of the presidential candidate tax plans reminded me of a passage in George Orwell’s dystopic novel 1984. The inner party’s chief torturer holds up his left hand with the thumb hidden and four fingers extended and asks the prisoner, “How many fingers am I holding up, Winston?” When Winston replies “four”, the official responds, “And if the party says it is not four but five – then how many?”

That’s a bit of what’s happening with Navarro’s explanation of Trump’s tax and trade policy. His argument goes something like this: Yes, Trump’s tax plan on its own would increase the deficit. But in tandem with his trade policy (as well as regulatory changes and a pro-carbon energy policy), their tax plan would not increase the deficit.

Here’s where Navarro’s argument about trade goes wrong: If the US government cuts taxes, the budget deficit gets bigger and more foreign capital must flow in to help finance the larger deficit.  Increased domestic investment will also draw more foreign capital.  How do other countries earn those dollars?  By exporting more to the United States (or importing less). Any macroeconomist will tell you that when the budget deficit and private borrowing both rise, so does the trade deficit.  The rule: Sources of sales by U.S. businesses must equal uses of those sale proceeds by US households.

Here’s the math:  C+I+G+X = C + S +T, where C = consumption of domestic goods, I = private investment in the United States, G = government spending, , X = net exports (exports minus imports), S = private saving, and T = net taxes (taxes minus government transfer payments to households).  If capital flows into the United States increase, I-S goes up, and if taxes are cut without an offsetting cut in government spending, G –T increases. To balance the equation, net US exports have to fall.

The Trump economic team argued instead that the budget deficit would not increase because the trade deficit would fall. This appears to be their logic:

Step 1.  Cut taxes.  With no response, the deficit grows.  They ignore that this step, by itself, would worsen the trade balance.

Step 2.   The lower corporate tax rates in Trump’s plan would encourage US firms to increase domestic investment.  They ignore that this step would worsen the trade balance even more.

Step 3 (the Orwellian one).  An improved trade balance would offset the tax cuts, so the deficit will not increase. 4 fingers raised = 5.

Thus, the Trump people have turned decades of economic theory and evidence on its head. But despite their best efforts, the four raised fingers are still four.

This article originally appeared on TaxVox.