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

Abstract

For apparently irreconcilable domestic political reasons, the United States is an outlier amongst economically advanced countries as the only one that does not have a value added tax (VAT), which is the conventional and WTO-sanctioned approach to applying an economically efficient and non-trade-distorting 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/sales tax burden from their country of origin. The perception that the lack of a VAT has put U.S. 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, amongst others. In this note, we quantify the impacts of such a BAT and demonstrate that it is trade-distorting, and economically damaging to the United States and to its trading partners. The BAT is not a VAT because of the trade-distorting effects at the product level, where substitution elasticities are high. The aggregate effects are negative because the trade disruption at the product level are much more powerful than the impact of export subsidies on the decision to export.