Most countries around the world and all high-income countries other than the United States have “border adjustments” in their tax code, but a key point to recognize is that border adjustments are typically part of a value-added tax–not the corporate income tax.
. . .the Trump administration proposal for revising the corporate income tax is actually a first-cousin-once-removed of a value-added tax.
Taylor cites scholars of various political persuasions in support of this analysis. Greg Mankiw makes a similar point. If you prefer taxing consumption to taxing saving and labor, then you should get to know the economics of the border-adjustment tax in the context of a shift from taxing corporate profits to taxing corporate net revenue.
But John Cochrane points out
a tax system in which you tax $100 of sales, but offer $99 of deductions (costs, wages, earnings retained for investment), then tax only the last $1, then tax that $1 again as personal income, would seem to offer lots of room for shenanigans on just what gets deducted. Along with interesting financial engineering to “invest” more earnings and pay less dividends and interest.
The more radically you reform taxes, the more you risk creating new distortions, both foreseen and unforeseen.
Tyler Cowen has a point about politics.
I say anything complicated they will just screw up, and the lack of transparency in the plan means eventually it will lead to a tax hike and furthermore a good deal of favoritism and rent-seeking along the way. Best hope is simply that they cut the corporate tax rate and don’t do much else on that front.
It is true that lowering the corporate tax rate would reduce the malincentive effects of loopholes in the tax. Lowering the stakes involved would lower the rent-seeking. Also, simply lowering the rate seems less risky (see John Cochrane’s whole post.
The economic theory of how a border-adjustment tax should work is worth knowing. However, theory tends to apply to concepts in the abstract. In practice, a lot of tax policy turns on what gets defined as taxable and what does not. And those regulatory and legislative decisions are where the rent-seeking and the distortions kick in.
Probably the biggest problem with these tax changes is the tax codes become regressive so taxes for the bottom 60 – 70% go up. This is after most state taxes are very regressive as well. While these changes in the long run are good, it will in the short run whack the Middle/Lower class when wages have been stagnant for 17 years.
I still think the develop world biggest supply problem is your basic Ross Douthat concern in which people are no longer having growing families. So it is impossible for developed world to escape the Japan demographic spiral in which both the AS-AD curves are shrinking.
I am trying to understand why the VAT+border adjustment won’t affect the balance of trade.
I have read several places (Auerbach’s “Choice between income and consumption taxes” paper, for example) that a VAT combined with a border adjustment (i.e., a tax on imports, and a subsidy for exports) will not affect the balance of foreign trade, even though a subsidy on exports and tax on imports would appear to increase exports and decrease imports.
The reason it won’t affect the BOT, as I understand it, is because a new VAT will increase US prices but won’t affect foreign prices. So foreign goods will become more attractive to US consumers (and US exports less attractive to foreigners?) by an exact amount to offset the effects of the border adjustment. They call this an appreciation of the *real* exchange rate of the dollar (which is the *nominal* exchange rate, multiplied by the ratio of foreign to US prices). R=($/unit foreign currency)x(Pf/Pus).
My question: Can the US price level go up simply because of the VAT, without decreasing the money supply (i.e., without reducing the number of dollars chasing all US goods)?
And if the VAT is what causes the US price level to go up, won’t eliminating the corporate tax in exchange for the VAT cause US prices to go back down? Both taxes would be passed onto the consumer (mostly), so it seems replacing a corp tax with a VAT would not affect US price levels.
I am not an economist, but I want to understand these things. Any feedback is greatly appreciated.
Or maybe the *real* dollar gets stronger because of a change in the *nominal* exchange rate? But why would that happen? Why would VAT+border adjustment cause the nominal dollar fx to strengthen, if US price levels were unchanged?
A VAT is a consumption tax neutral with respect to origin so domestic consumers will pay it whether imported or not, and as a consumption tax, it is just passed along by producers. It is not neutral with respect to destination, as domestic consumers will pay, whether imported or not, while foreign consumers will not, whether exported or not, but foreign consumers will pay their own VAT on their consumption. So foreign goods do not become more attractive domestically but are taxed on import and the tax passed along just like domestic goods. Price indices are generally total sales price so this can cause a increase when first imposed but also some subsequent decline as it can remove money from consumers pockets. It also matters what is done with the proceeds though. Reducing deficits and debt would reduce the money supply and tend to increase the exchange rate though reduced economic prospects could lower it. Government spending is mostly domestic and usually not consumer goods so could shift the BOT. Tax cuts could reduce or increase the money supply depending on whose taxes are cut and by how much. The bank would also take this into account when deciding how to compensate and it would take their cooperation to sustain a price increase. Corporate taxes are believed to fall mostly on their employees, some on investors, and to the extent they fall on consumers, it is not always domestic consumers. Incidence varies widely as many corps currently pay no taxes while others pay substantial amounts. It would tend to increase consumer prices some since it is paid by consumers though not wholly.
You might find Dean Baker interesting on this topic.
Lower tax rates mostly good — but diffuse benefits. With some new loopholes for the chosen (those currently favored by Trump & allies, at the time of passing).
There is VAT logic that is accurate, a tax on consumption more than on income, but I don’t think there are any OECD countries with a VAT that have no income tax.
Slovakia has fairly simple 20% VAT & 20% flat income tax. Too high, but simple to calculate; much seems dissipated in rent-seeking.
With “inequality” talk being so prevalent, there is about 0% chance of getting rid of the income tax, despite possibilities to change it. VAT would just add to the anti-growth tax collected by gov’t.