Why an Iran Deal Is Like a $400-Billion Tax Cut

November 20, 2014 Topic: EconomicsDiplomacyNonproliferation Region: IranUnited StatesEurope

Why an Iran Deal Is Like a $400-Billion Tax Cut

And it would come at a time when most industrial countries are too concerned about their fiscal deficits to propose new tax cuts.

The big date looms and the consequences for geopolitics could be even bigger: on November 24, Iran and the United States and five other leading nations, if all goes well, are scheduled to hold a summit in Vienna to complete negotiations on Iran's nuclear program in return for lifting Western sanctions. There is still a great deal of distrust on both sides, but the fact that both President Obama and President Rouhani want a deal suggests a breakthrough may be possible.

If the two sides can reach an agreement that eliminates sanctions on Iran's foreign trade, there could be three important consequences.

First, Iran would be able to increase oil exports by around one million barrels from June levels in the short term and possibly 1.5 million barrels over two or three years. The increase in Iranian exports at a time when demand is weak and there is already excess supply could drive the oil price into the $50-60-per-barrel range. This could produce a positive shock for the oil-importing countries and a negative shock for the oil exporters. Every $10 decline in the oil price could boost real GDP growth in the oil importing countries by 0.2 percent. It would be a de facto $400-billion tax cut at a time when most industrial countries are too concerned about their fiscal deficits to propose new tax cuts. The major winners would include Japan, India and Western Europe, because they import most of their oil. The United States would also benefit, because it still imports about one-third of its oil consumption.

The second positive consequence would be to cripple the economies of leading American enemies, such as Russia and Venezuela. Oil and gas account for 68 percent of Russian exports and 45 percent of government tax revenues. The recent decline in the oil price has already provoked the finance minister to say that Russia may not be able to increase military spending next year. The devaluation of the ruble has helped to offset some of the revenue impact of falling oil prices, but Russia had been budgeting for a $100-per-barrel oil price next year. If it drops into the $50-60-per-barrel range, Russia will be hard pressed to maintain spending, while the central bank could be forced to hike interest rates sharply in order to defend the ruble. The odds would increase of Russia experiencing a major recession after only 0.2 percent GDP growth this year.

Venezuela would be highly vulnerable to a major oil-price decline, because oil accounts for over 90 percent of exports and an even larger share of government revenue. The country is already confronting a fiscal deficit of 17 percent of GDP, so the loss of oil revenue could force the central bank to resort to hyperinflation to fund the government. Venezuela had chronic financial problems when oil was $100 per barrel because of economic mismanagement. A sharp oil-price decline will only intensify these problems and might finally force the government to default on its external debt. A large oil-price decline might also force President Maduro to curtail low-priced oil exports to countries in Central America and the Caribbean. These exports cost Venezuela $2.3 billion per annum.

The third consequence of a deal with Iran would be the possibility of Iran reengaging with the global economy after a prolonged period of isolation. Iran has 78 million people and a nominal GDP of $369 billion. The sanctions have crippled trade and investment flows with GDP contracting by 5.8 percent in 2012 and 1.9 percent in 2013.

Many Western companies have expressed an interest in boosting their trade and investment links with Iran if the sanctions are lifted. They could help to boost Iranian oil output by several hundred thousand barrels per day during the next few years. They could also help to revive the broader Iranian economy after a long period of recession. If Iran can reengage with the global economy, it could have benign consequences for political reform.

The regime could not remain as hostile to the West if foreign companies were creating jobs and boosting real incomes. The Iranian Revolutionary Guard oppose a deal, because they earn large sums violating the sanctions, but the Iranian people want to escape from such corruption and end Iran's status as a pariah state. These desires are why they supported Hassan Rouhani for president last year. The sanctions have also taken a toll on the U.S. economy. They have reduced U.S. exports by as much as $175 billion during the past seventeen years, according to the National Iranian American Council.

There is strong Republican opposition in the United States to a deal with Iran, so Mr. Obama will have to negotiate an agreement that will not require congressional approval for some time.

The Obama administration has not discussed the potential positive consequences of a nuclear deal with Iran, but it could to be a transforming event for both the global economy and geopolitics. It should start talking about these opportunities with the American people if it can reach a deal on November 24.

David Hale is the founding chairman of David Hale Global Economics; his website can be found at https://www.davidhaleweb.com/

Image: Iran president website