Americas Fiscal Cliff Can Be a Catalyst for Growth | Print |
Written by Vijay Govindarajan and Srikanth Srinivas   
Friday, 09 November 2012 05:00

As America turns its attention to the "fiscal cliff," the proposals on the table look at solutions that will either shrink the economy (e.g. cutting expenses and raising taxes) or make it stagnant (e.g. reduce tax rates but recover the revenue from fixing deduction loopholes).

Are there ways to expand the pie, instead? Here's one idea: turn the trade deficit into a trade surplus.

The trade deficit is goods and services we have consumed but have been provided by other countries. Over the last 10 years, the trade deficit has been between $400 billion a year and $800 billion a year.

For the purposes of this thought experiment, let us assume an average trade deficit of $600 billion a year. If every company had to pay a tax for the "deficit" they caused, and got a tax credit for the "surplus" they contributed; the goals and aspirations of entrepreneurs, businessmen and industrialists will be aligned with those of the country. By channeling the innovative spirit of the American people, we can start chipping away at the trade deficit and get to a trade surplus.

If we move from $600 billion a year trade deficit to $600 billion a year in trade surplus, that is $1,200 Billion a year added to our economy. If 50% of that goes towards salary and wages, that is $600 Billion in wages. That would be like adding 10 million new jobs that each paid a salary of $60,000 a year.

These are clearly back of the envelope numbers. They are meant to be directionally indicative rather than precise. But could something like this really happen?

Under the current system, companies like Walmart can import goods from the cheapest source without worrying about the national impact. Their primary focus is on getting a good return for their shareholders. But with a tax like the one described above, they would be forced to channel their creative energies to source locally where they can and import selectively as needed.

Walmart's Cost of Goods Sold is approximately $335 billion a year. If we account for a proportion of imports and the amount of exports and conservatively estimate that $125 billion is the net imports, and the tax rate on deficit contribution is 20%, that would be a $25 billion impact to shareholders. That is almost the same as their operating income for the year. Clearly, they would change the sourcing mix to lessen this impact. They would leverage their scale, reach and efficiencies to explore new products, markets, geographies and business models. If the tax credit is 10%, and they see a potential to save taxes, they would pursue opportunities to realize those savings. In other words, such a tax aligns Walmart's shareholder interests with those of the country. When it reaches a stage where a company like Walmart exports more than it imports, there is no doubt that US will have a trade surplus.

When the pie has expanded and we have those new jobs, and those workers pay their taxes and open their wallets and consume, there will be a multiplicative effect in the economy that will help chip away at the budget deficit.

In addition, this plan would introduce a new policy variable that can be used to channel the economy in the right direction. Let us say, the starting tax rate was 20% of the "deficit" created by a company, and the tax credit was to the tune of 10% of the "surplus" contributed by the company. If trade deficit gets worse, the tax can be increased to say 25% and the tax credit can also be raised to say 15%. If the trade surplus exceeds $600 billion, and the economy is growing at a torrid pace and we need to cool things off, the tax can be reduced to say 10% and the tax credit to say 5%. Who knows, a time may come when both the deficit tax and the surplus credit become zero because we have such good trade surpluses and budget surpluses.

Policy variables like these — that can directly influence the economy by providing incentives to grow the economy when growth is anemic, to tone it down if the growth gets too hot, and to align corporate interests with national interests — are critical to expanding the pie.

In conclusion, we believe that instead of narrowly focusing on a short-term solution to the Fiscal Cliff problem, if a longer-term solution is put in place to expand the pie, and a suite of policy variables are available to shape the growth of the economy, the pains of a fiscal cliff will have been well worth it.

Read more: Americas Fiscal Cliff Can Be a Catalyst for Growth