So Would the GOP Border Adjustment Really Be a Big Tax on Consumers?

 

House Republicans — and maybe President Trump, too — want to shift the US corporate tax system to a destination-based tax with a border adjustment. There’s been a lot of confusion about this border adjustment feature. Wall Street Journal reporter Richard Rubin offers a good explanation:

Think of it as a tax getting added at the border to imports and subtracted from exports. Target Corp.’s cost of buying toys from China wouldn’t be deductible from U.S. taxes. Exports—think of an American apple farm’s shipments to Canada—wouldn’t count as income for U.S. tax purposes. The Republican plan would add the border adjustment to the U.S. corporate income tax, which is expected to drop to 20% from 35%. So the tax on imports for corporations would be 20%.

You can see why critics, including large retailers, have called this a consumer tax. Some conservatives don’t seem to like it, either. In a Wall Street Journal ad, Steve Forbes argued that this “costly new national sales tax on imports” would “dramatically raise prices of everyday goods and services.”

But would it, really? What happens to the dollar is key here. Economists typically predict the dollar would rise in value by as much as 25% in response to the border adjustment. That would make imports cheaper and offset the tax change. So we’re good.

But what works on a blackboard or in a computer model might not work exactly the same way in the wild. In a new FAQ note on the border adjustment issue, Goldman Sachs takes a look at this question about the dollar (italics mine):

Q: Proponents say the transition to a border adjusted tax will be seamless because the dollar will appreciate immediately to offset the tax impact. Do you agree?

A: No. Proponents argue that nominal exchange rates would adjust immediately to offset the impact of border adjustment, resulting in no impact on consumer prices, corporate profits, or trade flows. In particular, a 25% appreciation of the dollar would be required if the statutory corporate tax rate were 20%. We are skeptical that the transition to DBTBA would be this smooth, for two reasons.

First, dollar appreciation would likely be incomplete in the short run. The current proposal would probably not be judged WTO compliant, and FX markets would therefore likely assign some probability to a policy reversal or foreign retaliation, either of which would undo the exchange rate impact of DBTBA. In addition, many US trading partners manage their currencies. Trying to prevent depreciation would arguably be counterproductive and perhaps a lost cause in the long run, but some countries might still try to mitigate the exchange rate volatility, especially if they thought the policy would soon be reversed.

Second, even if nominal exchange rates fully adjusted immediately, the prominent role of the dollar in trade invoicing—93% of US imports and 97% of US exports are invoiced in dollars—means that the impact on US companies’ import costs and export revenues would be incomplete in the short run.

The transition to DBTBA would likely feature some combination of partial dollar appreciation, higher consumer prices, a hit to the profit margins of US net importers and a boost to the margins of US net exporters, and substitution of domestic products for imports. US residents would experience a decline in their foreign currency-denominated wealth and liabilities, while foreign residents would experience an increase in their dollar-denominated wealth and liabilities in terms of their home currency.

Generally the financial giant sees a lot of uncertainty. Take the impact on GDP growth:

On the positive side, companies might shift production to the US as a result of the lower statutory rate paired with DBTBA. In addition, imports would likely decline as consumers substituted toward cheaper domestic goods. But on the negative side, exports could fall for the same reason if the dollar appreciated more quickly than US exporters cut prices, or if foreign countries imposed retaliatory tariffs. Furthermore, the hit to US net foreign assets would impose a negative wealth effect on consumption. Finally, the sudden policy change might cause some disruption and uncertainty that could depress output.

So don’t do the border adjustment? (And by the way, if consumer prices do rise, lower-income Americans would be hardest hit because they spend a greater share of their income on imported goods, such as at Walmart.) Well, Goldman isn’t saying that, either:

While the transition is unlikely to be frictionless, DBTBA is intended to solve important problems, including the shifting of profits and production abroad by US companies. To the extent that the policy succeeds in reducing tax avoidance through transfer pricing and in raising revenue to finance lower statutory rates—a benefit that is less clear in the long run—some short-run transition costs might be justified.

Hey, public policy is usually about tough tradeoffs, not silver bullets.

There are 7 comments.

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  1. Joseph Eagar Member
    Joseph Eagar
    @JosephEagar

    I’m not very familiar with the arguments for/against tariffs, but it seems to me that higher consumer prices is the entire point of the exercise; I believe the argument goes that, ideally, tariffs both raise the savings rate and depreciate the real exchange rate simultaneously, without the need for a coordinated tight-fiscal/loose-monetary policy mix (which is what we’re doing now).

    I’ve always been more comfortable with engineering the current account via fiscal savings then tariffs (along with other tax-based “internal devaluation” schemes).  Ultimately, in a low-saving economy like the U.S. our current account balance is the product of fiscal policy, and anything that gives policymakers the illusion that isn’t the case—and thus makes fiscal profligacy more tempting—should be avoided.

    • #1
  2. I Walton Member
    I Walton
    @IWalton

    This tax is  equivalent to a 20% devaluation, which is big and will have intended and unintended consequences.   Since the US is the only country that cannot devalue this is an interesting approach.   It is not protectionist any more than  devaluations by normal countries are protectionist. It avoids targeting individual countries  is uniform and across the board.  Hopefully it will also divert us from beating up on China and trying to get them to revalue.  That’s dangerous.     The impact of this tax depends on the corporate tax rate meaning revenue hungry administrations will be even less willing to eliminate the corporate profits tax and raising the tax raises the level of protectionism.  A better policy would be a 10%-20% across the board tariff and the elimination of the corporate profits tax with corporate profits taxed as income of the holder of record, or a VAT with it’s border adjustments.  We can’t know how much the dollar will appreciate as a result, but it must appreciate.

    • #2
  3. Steve C. Member
    Steve C.
    @user_531302

    There is rent being sought here. I just don’t know by whom.

    So a key assumption is exchange rates will act as assumed. I’ll go along if every economist who believes that, agrees to put 25% of his net worth in a trust that is forfeit to the charity of his choice if that doesn’t happen within 12 months.

    • #3
  4. Joe P Member
    Joe P
    @JoeP

    I am now confused. What is the difference between “border adjustment tax” and a VAT?

    Besides the name, which is clearly chosen to appeal to the new Trumpian stance on trade and not sound like the dirty European Union idea that everyone already has established skepticism towards.

    • #4
  5. David Foster Member
    David Foster
    @DavidFoster

    If cost of buying imports is not deductible from income for US tax purposes, it would totally destroy any low-margin importer, even if US corporate income tax rates were to be significantly reduced.

    If your revenue is $1000, your cost of goods is $700 (imports), and your other expenses are $100, then your pretax net income is $200 at presently calculated.  But if the cost of import purchases is not deductible, then your pretax net becomes $900.

    • #5
  6. Steve C. Member
    Steve C.
    @user_531302

    Joe P (View Comment):
    I am now confused. What is the difference between “border adjustment tax” and a VAT?

    Besides the name, which is clearly chosen to appeal to the new Trumpian stance on trade and not sound like the dirty European Union idea that everyone already has established skepticism towards.

    A vat is a tax applied any time goods are sold in the supply chain presuming each owner adds some value. I buy raw cotton and make cotton thread I sell to you for use in knitting shirts. Today that’s a sale that is not subject to sales tax because sales taxes are applied on sales to consumers. It’s a hidden tax to the consumer. while the shirt they buy says price plus sales tax on the receipt, it does not include vat taxes applied at each step in the supply chain.

    • #6
  7. I Walton Member
    I Walton
    @IWalton

    Steve C. (View Comment):

    Joe P (View Comment):
    I am now confused. What is the difference between “border adjustment tax” and a VAT?

     

    A vat is a tax applied any time goods are sold in the supply chain presuming each owner adds some value. I buy raw cotton and make cotton thread I sell to you for use in knitting shirts. Today that’s a sale that is not subject to sales tax because sales taxes are applied on sales to consumers. It’s a hidden tax to the consumer. while the shirt they buy says price plus sales tax on the receipt, it does not include vat taxes applied at each step in the supply chain.

    Every receipt I’ve ever seen in a country with a Vat says, VAT  X percent, or IVA X percent.  It is not hidden, it looks like a sales tax but it is collected on the value added at each stage as you say.  It is different from the border adjustment tax in that only imports and imported parts pay the tax and  are deducted from corporate tax by not allowing a deduction.  Almost certainly adding this dimension of complexity will lead to discovery of means to avoid it.   Really not wise.  The VAT would be better is almost impossible to avoid and is almost self collecting.

    • #7
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