The United States may be about to implement a border adjustment tax. The Republican Party, now in control of the legislative and executive branches, views a BAT – which would effectively subsidize US exporters, by giving them tax breaks while penalizing US companies that import goods – as an important element of corporate-tax reform.
They claim that it would improve the US trade balance while boosting domestic production, investment and employment. They are wrong.
The truth is that the Republicans’ plan is highly problematic. Along with other proposed reforms, the BAT would turn the US corporate income tax into a tax on corporate cash flow (with border adjustment), implying far-reaching consequences for US companies’ competitiveness and profitability.
Some sectors or firms – especially those that rely heavily on imports, such as US retailers – would face sharp increases in their tax liabilities; in some cases, these increases would be even greater than their pre-tax profits.
Meanwhile, sectors or firms that export, like those in manufacturing, would enjoy significant reductions in their tax burden. This divergence seems both unwarranted and unfair.
The BAT would have other distributional implications, too. Studies indicate that it may hit consumers among the bottom 10 percent of income earners hardest.
Yet, it has been promoted as a way to offset the corporate-tax cuts that Republicans are also pushing – cuts that would ultimately benefit those at the top of the income distribution.
Making matters worse, the BAT would not actually protect US firms from foreign competition. Economic theory suggests that, in principle, a BAT could push up the value of the dollar by as much as the tax, thereby nullifying its effects on the relative competitiveness of imports and exports.
Moreover, the balance-sheet effects of dollar appreciation would be large. Because most foreign assets held by US investors are denominated in a foreign currency, the value of those assets could be reduced by several trillion dollars, in total.
Meanwhile, the highly indebted emerging economies would face ballooning dollar liabilities, which could cause financial distress and even crises.
Even if the US dollar appreciated less than the BAT, the pass-through from the tax on imports to domestic prices would imply a temporary but persistent rise in the inflation rate.
Some studies suggest that, in the BAT’s first year, the new tax could push up US inflation by 1 percent, or even more.
The US Federal Reserve may respond to such an increase by hiking its policy rate, a move that would ultimately lead to a rise in long-term interest rates and place further upward pressure on the dollar’s exchange rate.
Yet another problem with the BAT is that it would create massive disruptions in the global supply chains that the US corporate sector has built over the past few decades.
By undermining companies’ capacity to maximize the efficiency of labor and capital allocation – the driving motivation behind offshoring – the BAT would produce large welfare costs for the US and the global economy.
The final major problem with the BAT is that it violates World Trade Organization rules, which allow border adjustment only on indirect taxation such as value-added tax, not on direct taxes, like those levied on corporate income.
Given this, the WTO would probably rule the BAT illegal. In that case, the US could face retaliatory measures worth up to US$400 billion per year if it didn’t repeal the tax. That would deal a serious blow to US and global GDP growth.
So how likely is the US to enact the BAT?
The proposal has the support of the Republican majority in the House of Representatives, but a number of Senate Republicans are likely to vote against it. Democrats in both houses of Congress are likely to vote against the entire proposed corporate-tax reform, including the BAT.
The executive branch is also split on the issue, with President Donald Trump’s more protectionist advisers supporting it and his more internationalist counselors opposing it. Trump himself has sent mixed signals.
Disagreement over the BAT extends to business as well, with firms that export more than they import supporting it, and vice versa.
As for the general public, low and middle-income households should oppose the BAT, which would drive up prices of the now-cheap imported goods that these groups currently consume, though Trump’s blue-collar constituents, particularly those who work in manufacturing, may support the measure.
Ultimately, the case for the BAT is relatively weak – far weaker than the case against it.
While this may be enough to ensure that it doesn’t pass, there are strong protectionist forces in the US government pushing hard for it and similar policies. Even if the BAT is rejected, the risk of a damaging global trade war triggered by the Trump administration will continue to loom large.
Copyright: Project Syndicate
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