Kenneth Rogoff
Kenneth Rogoff, Professor of
Economics and Public Policy at Harvard University and recipient of the
2011 Deutsche Bank Prize in Financial Economics, was the chief economist
of the International Monetary Fund from 2001 to 2003. The co-author of This Time is Different: Eight Centuries of Financial Fol… read more
CAMBRIDGE
– In many ways, the Republican Party’s plan to implement a “border
adjustment tax” in the United States is the virtual complement of the
physical wall President Donald Trump plans to erect on the US-Mexican
border. Although the border adjustment tax has not seeped into public
consciousness in nearly the same way as Trump’s physical wall has, it
could end up affecting the average American a lot more – and not
necessarily in a good way.
On the surface, the
basic idea is to slap a tax of, say, 20% on imports, and to provide tax
breaks worth a similar amount on exports. Most populists’ gut reaction
is that this must be fantastic for US jobs, because it discourages
imports and encourages exports. Unfortunately, as many have pointed out, there is a loose screw in this logic, which is that the United States has a floating exchange rate.
A stronger dollar – a
likely result of imposing a border adjustment tax – makes it cheaper
for Americans to buy imports (because a dollar buys more foreign
currency); conversely, a stronger dollar makes US exports more expensive
to foreigners. In fact, the baseline textbook result is that the
exchange-rate effect would fully offset the tax, leaving the trade
balance unchanged. If you think the Republicans’ proposal sounds like
hocus pocus, you might be right, but let’s hold that thought.
Several highly
regarded academic economists favor the border adjustment idea, but for
entirely different reasons. They take it as an article of faith that the
exchange rate will in fact rise to neutralize the trade effects of a border adjustment tax. But they like it anyway.
First, the US imports
a lot more than it exports, so it runs a large trade deficit, with the
broadest measure (the “current account”) at around 2.5% of GDP. While
that is a vast improvement over the 6%-of-GDP deficits the US was
running a decade ago, the US still imports considerably more than it
exports, meaning the government stands to collect far more revenues from
its 20% tax on imports than it would have to give in tax breaks to
exporters. Indeed, the tax-subsidy schedule could, on paper at least,
bring in roughly $90 billion a year.
And the magic doesn’t
stop there. Although it might surprise people who are used to thinking
of imports and exports as a pure “us versus them” phenomenon, in fact
roughly half of all trade is intra-firm – transactions between foreign
and US divisions of the same company. And because US corporate taxes are
among the world’s highest, firms will go to great lengths to assign as
much value as they can to foreign subsidiaries, and as little as
possible to US companies.
One way to do this is
by putting an artificially high bookkeeping price on intra-firm
imports, and an artificially low bookkeeping price on exports. Under-
and over-invoicing is a time-honored way to get around taxes and
controls. When a transaction is all “in-house,” it essentially just
involves accounting sleight of hand to book profits in low tax
jurisdictions.
As the University of California at Berkeley’s Alan Auerbach first pointed out,
the border tax adjustment is a way to push back on under- and
over-invoicing in a high-tax jurisdiction such as the US. So, all in
all, even if a border adjustment tax does not directly make US goods
more competitive, it is an efficient way to raise revenues, potentially
making room for other tax cuts.
So what could
possibly be wrong with such a technocratically sound idea? First, it
relies on some heroic assumptions – for example, that people cannot
easily game the labyrinthine system and that foreign governments will
exercise restraint in retaliating. Second, it ignores a host of
difficult transition problems.
For starters, the
overwhelming majority of US imports are priced in dollars, not foreign
currency. So, even if foreign currencies become cheaper, it might not
help importers locked into dollar contracts. Their costs would just be
20% higher because of the import tax. And, despite the tax subsidy, some
exporters would lose, because, as a recent New York Federal Reserve note points out, they rely on imported intermediate goods in producing their products.
Another problem is
that a stronger dollar would mean a massive wealth loss for Americans,
because the value of many foreign assets would go down, as my colleagues
Emmanuel Farhi, Gita Gopinath, and Oleg Itskhoki have discussed.
The biggest problem of all, though, is the blithe assumption that the
dollar exchange rate would neatly move to offset the tax/subsidy scheme.
If there is anything
that the past 40 years of exchange-rate research have taught us, it is
that exchange rates can move wildly away from their fundamentals for
many years at a time. It is thoroughly unrealistic to assume that a
border tax will quickly lead to a sharp offsetting movement of the
dollar. The process could take many years, and the short-term effects on
US unemployment easily could be negative.
True, high border
taxes could boost US employment. The scheme would require a huge
increase in customs agents, and it would most likely lead to significant
expansion in the underground economy as people seek to evade the taxes.
But are those really the types of jobs proponents of a border tax have
in mind?
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