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Aftershocks: Quantifying the Economic Impacts of a US Border Adjustment Tax

2017-06-08 20:32:36

Aftershocks: Quantifying the Economic Impacts of a US Border Adjustment Tax

Dan Ciuriak and Jingliang Xiao

For apparently irreconcilable domestic political reasons, the United States is an outlier among economically advanced countries as the only one that does not have a value-added tax (VAT), which is the conventional and World Trade Organization-sanctioned approach to applying an economically efficient and non-tradedistorting consumption tax. Under a VAT regime, the same tax is applied on imports as on domestic purchases. This means that all goods sold in a country are subject to the same amount of tax regardless of
country of origin. At the same time, all VAT paid on intermediate inputs – whether domestically sourced or imported – in producing a good is refunded for goods that are exported, which provides a level playing field for exports with products from other sources since they all face the same sales taxes applicable in the destination country, with no consumption- or sales-tax burden from their country of origin.

The perception that the lack of a VAT has put US trading firms at a disadvantage in international trade has led to attempts to construct an alternative tax that replicates in some sense the trade neutrality of a VAT. Such a “border adjustment tax” (BAT) has been promoted by Speaker of the House Paul Ryan and supported by White House trade policy adviser Peter Navarro, among others. In simple accounting exercises that ignore the reaction of firms to the changed incentives, the BAT
can be characterized as having a neutral effect on the overall balance of US trade. Critically, this finding depends on an exactly offsetting revaluation of the US dollar. This is an unlikely outcome, because, at the product- and firm-level, the BAT invites switching from imported inputs to domestic inputs, and switching from domestic sales to foreign sales, to reduce tax liabilities. Given differences across firms and products in the ability to take advantage of such switching, the BAT implies potentially significant shocks to established value chains involving US firms.

We quantify the impacts of such a BAT and demonstrate that it is trade-distorting and economically damaging to the United States and its trading partners. The BAT is not a VAT because of the tradedistorting effects at the product level, where substitution elasticities are high. The aggregate effects are negative because the disruption of imports at the product level is much more powerful than the impact of export subsidies on the decision to export.

Canada is heavily exposed to the ramifications of a BAT: the preliminary findings suggest a decline in real GDP of about 1 percent and a decline in Canadian prices of about 2 percent, as Canadian firms reduce prices to limit the erosion of their exports to the United States