Strange, but True: Trump's Pro-Growth Policies Probably Mean Larger Trade Deficits

During his campaign, Donald Trump made dozens of promises that he vowed to keep once in the Oval Office. The vast majority of these promises were centralized around one key idea: boosting GDP growth in America.

Over the previous decade, GDP growth in the U.S. can be described as falling somewhere between erratic and subpar. The Great Recession took an enormous toll on the U.S. economy, and periods of deflation have pulled the rug right out from under businesses. Trump has promised to change this situation.

Image source: U.S. Department of Homeland Security, Flickr.

Trump's GDP growth plan, in a nutshell

The key component of Trump's change is tax reform at the individual and corporate level. Individually, Trump favored adopting the House Republicans' individual federal income-tax proposal, which would lower taxes for most Americans and simplify them for nearly all Americans. Currently, there are seven progressive ordinary income-tax brackets. Trump's plan would entail just three progressive brackets, with the elimination of practically all credits and deductions, save for a select few (e.g., charitable giving deduction and mortgage interest deduction). In return, taxpayers would see a more than doubling in their standard deduction.

As for businesses, Trump has ambitious plans to cut the corporate income-tax rate by more than half, to 15% from 35%. A lower corporate income-tax rate would allow businesses to keep more of their profits with the hope that they'll reinvest in innovation and hiring. There would also be a component allowing for a special repatriation holiday tax rate of 10% for the roughly $2.5 trillion in income currently being held overseas. Bringing this capital back into the U.S. could spur expansion and jobs growth, in the eyes of the president.

Beyond tax reform, Trump has plans to introduce a $550 billion infrastructure bill designed to repair our aging nation's bridges, roadways, and airports over a 10-year timeframe. He also aims to boost defense spending, promote the domestic energy industry to reduce our reliance on foreign fossil fuels, and renegotiate a number of America's trade deals.

If Trump were to get everything he vowed during his campaign, he suggests that U.S. GDP growth could consistently tip the scales at between 3% and 4%.

Image source: Getty Images.

How's this for irony?

However, as strange as this might seem, Trump's tactics to reignite growth in the U.S. economy and rework trade deals with foreign countries may have the effect of increasing, not decreasing, the U.S. trade deficit with its largest trade partners.

A lot of focus has been given recently to talk of a border adjustment tax, or BAT. If a BAT were implemented, U.S. companies that are exporting goods outside the U.S. would receive a rebate that would wind up exempting them from taxation. In return, goods being imported into the U.S. would be hit with an import levy that would make them more expensive. The ultimate goal of the BAT would be to encourage domestic consumers to buy domestic goods.

As you might imagine, this idea has some consumers and pundits up in arms, since it could increase the price of goods that are traditionally imported into the United States (consumer electronics, for example). It could also incite a retaliatory trade war with other nations that object to having a tariff added to their exported goods. This alone could threaten to widen the deficit.

But there's much more at stake.

Image source: Getty Images.

The movement of the U.S. dollar will likely be pivotal in determining whether Trump has any shot of narrowing U.S. trade deficits with those of its key partners.

Generally speaking, the U.S. dollar tends to move in step with the U.S. economy. In other words, if the growth picture is brightening and the clouds are clearing, domestic and even foreign investors buy the dollar, pushing it higher. If economic growth weakens or the outlook becomes murky, the U.S. dollar tends to move lower.

Why does this matter? On a surface-scratching basis, if the U.S. dollar is rising, the major basket of currencies that it's often compared against is probably falling. That would mean consumers and businesses in foreign markets could buy fewer U.S. goods with their currency, but that U.S. consumers could buy more imported goods since their currency had appreciated in value. That would most likely work to widen the deficit.

The BAT would only exacerbate this effect. According to economists, if the dollar behaved as it should on paper, it would be expected to increase by between 15% and 25% over the course of a couple of years. A stronger dollar would seem to be the enemy of President Trump and his growth policies, since it would likely encourage imports and discourage foreign countries from purchasing U.S. exports.

Despite Trump's best efforts, the U.S. trade deficit could actually widen with his approach. Only time will tell if that's the case.

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