Trade Deficit Drags on Recovery
Overall, the deficit is a significant tax on aggregate demand and jobs creation, just as a government deficit increases demand for U.S.-made products and boosts employment. In the coming months, higher oil prices and stronger inventory build should push up the trade deficit again and drag on economic recovery.
Persistently high trade deficits and continuing low real estate values are the most significant reasons why the current economic recovery is slowest since the Great Depression, and why the Congress and President face so much difficulty stabilizing federal finances without risking a second, deeper recession.
Consumer spending has expanded, though haltingly, and the annual federal deficit increased from $161 billion before the financial crisis to more than $1 trillion over the last five years, injecting enormous additional demand into the system. However, too many consumer dollars go abroad for Middle East oil and Chinese goods that do not return to buy U.S. exports.
Businesses, consequently, are pessimistic about future demand for U.S.-made goods and services. And bearing higher taxes, more burdensome regulations, and increased benefits costs mandated by Obamacare, they are reluctant to hire in the United States and seek opportunities abroad.
Those barriers frustrated the virtuous cycle of temporary tax cuts and additional government spending, new hiring, and additional household spending that the first-term Obama stimulus sought to beget.
Now, the Fiscal Cliff deal will raise combined federal and state tax rates for many small businesses on expansion and reinvestment to maintain existing facilities to more than 50% -- even more in California and New York.
Prior to the Fiscal Cliff tax increases, economists predicted growth of about 2% for 2013. However, these new taxes on small business investment and innovation strike at the heart of this once vibrant American jobs-creating machine. Look for growth in the range of 1.5% and a tougher jobs market at least through mid-year.
Growth below 2% is difficult to sustain. Any disruption could set off a cycle of layoffs, falling consumer spending and ultimately a recession that pushes unemployment into double digits.
Should tax increases be necessary to reach a political compromise to further reduce the budget deficit, Congress should heed President Obama's recommendation to close loopholes like the carried interest provision -- which permits Wall Street traders and executives throughout the economy to pay lower tax rates than ordinary wage earners. That would do the least damage to aggregate demand, and actually improve economic incentives for productive investments in the United States and stimulate growth.