This month’s blog is an explanation of Trump’s proposed borer adjustment tariff and its possible ramifications; but first, a brief economic history lesson. In October of 1929 on Black Tuesday, the stock market crashed and a recession was imminent. However, as a result of monumental blunders in both fiscal and monetary policy, a bad recession was turned into a depression. The fiscal policy came in the form of the Smoot-Hawley Tariff also known as the Tariff Act of 1930. This act raised tariffs on over 20,000 goods and services that were being imported into the United States from foreign countries. The logic, according to Congress, was simple. As a result of the stock market crash and looming recession, aggregate demand was decreasing as was output as a result of increasing inventories, and as a result, unemployment was increasing. The tariff would help rectify this by making foreign goods more expensive, thereby increasing purchases of American goods, reduce inventories, spur production to replenish the inventories and thus lowering unemployment and ending the recession.
What Congress failed to realize (funny how some things never change), that, unlike today, the United States was a net exporter of goods and services. In other words, we sold more to foreign countries than we purchased from them and all foreign countries that we traded with reciprocated with their own tariffs, thereby making American goods more expensive abroad. As a result of the tariffs and worldwide recession/depression, word trade plummeted by over 65% in 4 years (chart). Fortuitously, Congress, and the rest of the world, realized their folly and reversed the tariffs, but the damage had already been done.
Enter the border adjustment tax (BAT). In theory, it looks good, but there are generally unintended consequences. The purpose of the BAT is to incentivize exports and discourage imports. While some may think that a BAT is a tariff, it isn’t. It would prevent companies from deducting expenses associated with importing goods for resale. It has the additional benefit of exempting exports from being taxed on any profit those exports may generate. In theory, this would encourage firms to buy American to avoid the increased cost of taxes on imports and to nurture additional markets abroad and in the long be revenue neutral or slightly positive for the US.
The attached chart is from the US Tax Foundation:
An origin based-tax (like what we have in place now) is one that taxes goods based on where they are produced, regardless of where they are consumed. As such, an origin-based tax applies to both goods produced and consumed domestically (purely domestic goods) and to goods produced in the U.S. and consumed in foreign countries (exports). In the two-by-two matrix (below), an origin-based tax is applied to the top and bottom boxes on the left.
The attached chart is from the US Tax Foundation:
An origin based-tax (like what we have in place now) is one that taxes goods based on where they are produced, regardless of where they are consumed. As such, an origin-based tax applies to both goods produced and consumed domestically (purely domestic goods) and to goods produced in the U.S. and consumed in foreign countries (exports). In the two-by-two matrix (below), an origin-based tax is applied to the top and bottom boxes on the left.
A destination-based tax is one that taxes goods and services based on where they are consumed, regardless of where they are produced. In our two-by-two matrix, a destination-based tax system is levied on goods and services in the two top boxes: goods produced and sold domestically (purely domestic products) and goods produced in foreign countries and sold domestically (imports).
As a result, a destination-based tax is neutral with respect to domestic consumption but could be positive if consumption of goods produced domestically increase and be profitable for businesses if exports increase.
What could go wrong? What lawmakers aren’t taking into effect is that we import goods for a reason, i.e., cheaper prices. As a result of higher domestic prices, consumption/demand will decrease which will have a multiplier effect. In addition, it never ceases to amaze me how Congress fails to learn from history. It is quite in the realm of possibility that other countries will reciprocate with a BAT of their own or just a simple tariff. For the most part, I like Trumps pro-business agenda of lower taxes and less regulation, however, I think the BAT tax will do more harm than good.
As a result, a destination-based tax is neutral with respect to domestic consumption but could be positive if consumption of goods produced domestically increase and be profitable for businesses if exports increase.
What could go wrong? What lawmakers aren’t taking into effect is that we import goods for a reason, i.e., cheaper prices. As a result of higher domestic prices, consumption/demand will decrease which will have a multiplier effect. In addition, it never ceases to amaze me how Congress fails to learn from history. It is quite in the realm of possibility that other countries will reciprocate with a BAT of their own or just a simple tariff. For the most part, I like Trumps pro-business agenda of lower taxes and less regulation, however, I think the BAT tax will do more harm than good.
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