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Proposed Tax Overhaul Would be Trade Neutral, Offers Benefits and Challenges, Report Finds

Monday, February 27, 2017
Sandler, Travis & Rosenberg Trade Report

A controversial overhaul of the U.S. tax code proposed by House Republicans would not put the U.S. at a trade advantage or disadvantage, according to a recent report from independent research organization The Tax Foundation. The plan does offer some potential benefits but also presents challenges, the report said. President Trump is reportedly warming to the plan, which appears to have little support in the Senate, and said Feb. 23 that it “could lead to a lot more jobs in the United States.”

The House GOP plan would convert the U.S. corporate income tax from an origin-based tax (based on where goods are produced) to a destination-based cash flow tax (based on where goods are consumed). This shift would be achieved through a border adjustment that would eliminate the tax deduction for costs associated with imported articles or inputs and provide a tax exemption for export revenue.

The report asserts that both origin- and destination-based taxes impact trade in the same way and that switching from one to the other would thus not alter the U.S. trade balance. While it appears that an origin-based tax punishes exports and subsidizes imports and that a destination-based tax does the opposite – a foundational claim made by supporters of the House GOP plan – the report states that this view is wrong. “This is because exports and imports are two sides of the same coin,” the report states. “A country’s exports are the price it pays in order to purchase goods from or invest in foreign countries. Likewise, imports are the returns, or income, a country receives from international trade and investment.”

There are some non-economic benefits of switching to a destination-based tax, the report states. Among other things, a border adjustment would create an incentive to shift profits (and possibly real economic activity) to the U.S. and allow for a simplification of the tax system. It would also raise more than $1 trillion in revenue with “relatively little economic harm and in a relatively progressive fashion, meaning it falls most heavily on high-income taxpayers.” By contrast, critics of the proposal argue that the border adjustment would increase the cost of everyday products such as food, gas, and clothing by up to 20 percent.

However, the report adds, there are potential challenges in switching systems as well. Perhaps the most significant is that it could run afoul of World Trade Organization rules, particularly those that prohibit discrimination against imports in favor of the same domestic goods. There are also questions about implementation (e.g., ensuring that exports get a full rebate and that all imports are subject to the border adjustment) and transition (e.g., the tax could fall on consumers and producers in the short run if a compensating exchange rate adjustment is slow to occur).

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