Martin Feldstein had a recent piece in the WSJ that defended the idea of a border tax adjustment, which would be a part of the proposed corporate tax reform. He points out that if imports were no longer deductible, and exports received a subsidy, then the border adjustment would not distort trade. Rather the effect would be exactly offset by a 25% appreciation of the dollar. I certainly understand that this would be true of a perfect across-the-board border tax system. But is that what we will have?
1. Will the subsidy apply to service exports? (Recall that services are a huge strength of the US trade sector.) Let's take Disney World, which makes lots of money exporting services to European, Canadian, Asian and Latin American tourists visiting Orlando. Exactly how will Disney determine the amount of export subsidy it gets? Do they ask each tourist what country they are from, every time they buy a Coke? That seems far fetched---what am I missing? If Disney doesn't get the export subsidy, then the 25% dollar appreciation would hammer them, and indeed the entire US service export sector.
2. What about all those corporate earnings that are supposed to be repatriated? (And future earnings as well.) If the dollar appreciates by 25%, then doesn't this hurt multinationals? Or am I missing something?
Update: It just occurred to me that corporate cash stuffed overseas is probably held in dollars. But future overseas earnings may still be in local currency.
Keep in mind that the prediction of 25% dollar appreciation is from the supporters of the plan, like Martin Feldstein. If you did this sort of adjustment without any dollar appreciation, the impact would be devastating on companies like Walmart. Given the Fed's 2% inflation target, how could they pass along a (effective) 25% tariff on almost everything they sell?
It's clear to me that I am missing something here. Can someone who knows more about the nuts and bolts of border adjustment taxes please explain exactly how this is supposed to work? I'm not saying the border tax is a bad idea--I'm agnostic so far. But unless I get good answers here, I'd recommend they not do it, or perhaps phase it in extremely gradually (like 1%/year for 25 years), and see what sort of side effects occur before going all the way to a 25% dollar appreciation.
Not to mention this violates WTO rules, which the US has previously argued must be adhered to. (Insert Trump sarcasm here.)
PS. Feldstein makes the following claim:
Since a border tax adjustment wouldn't change U.S. national saving or investment, it cannot change the size of the trade deficit. To preserve that original trade balance, the exchange rate of the dollar must adjust to bring the prices of U.S. imports and exports back to the values that would prevail without the border tax adjustment. With a 20% corporate tax rate, that means that the value of the dollar must rise by 25%.
With a 25% rise in the value of the dollar relative to foreign currencies, the $80 net price of U.S. exports would rise in the foreign currency to the equivalent of 1.25 times $80, or $100, and therefore back to the initial price. Similarly, the 25% rise in the value of the dollar would reduce the real import price to the U.S. retail customer back to $125/1.25, or $100, as it is without the border tax adjustment.
Although the combination of the border tax adjustment and the stronger dollar leaves exports and imports unchanged, it has the important advantage of raising substantial tax revenue. Because U.S. imports are about 15% of GDP and exports only about 12%, the border tax adjustment gains revenue equal to 20% of the 3% trade imbalance or 0.6% of GDP, currently about $120 billion a year. At that rate, the border tax adjustment would reduce the national debt by more than $1 trillion over 10 years.
That makes no sense to me. If the tax raises lots of revenue, then why doesn't national saving go up? Isn't government tax revenue a part of national saving? Feldstein is far better at public finance than I am, so I must be missing something here.
Can anyone help me?
Update#2: I forgot about foreign dollar denominated debts. How are they handled if the dollar appreciates by 25%? Tough luck?