Yves Nosbusch 




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How is US economic policy likely to change? dotted

On the economic front, the new US President's priorities seem to lie in two main areas: fiscal policy and international trade. Regarding fiscal policy, a large-scale stimulus programme is under consideration with tax cuts for both companies and individuals, as well as a substantial investments in infrastructure. On the topic of international trade, the general intention seems to be to further support domestic production, but there is still much uncertainty regarding the exact form of the measures to be adopted.


One potential measure that straddles both of these areas is the idea of a border adjustment tax. It is part of the “Ryan-Brady” tax reform bill put forward by Republican members of the House of Representatives. At this point, it is difficult to assess how likely the adoption of such a measure would be, since the US President's position on the matter is not clear.



Simply put, it would involve a global tax on imports, including imports of intermediate goods used in US production. On the other hand, revenues generated by US exports would no longer be subject to tax. In concrete terms, this would mean that when a retailer imports a product for resale on the US market, for example, it could no longer deduct the cost of the imported product from its taxable income. To maintain its margin, the retailer would therefore have no choice but to increase the price of the imported product. It comes as no surprise that the retail sector is generally not in favour of such a measure. In contrast, a US producer exporting to the rest of the world would no longer pay tax on the income generated by such exports. In theory, this would allow it to cut its export prices without eating into its margin, making it more competitive on global markets. Unsurprisingly, many US exporters look favourably on this measure.



This raises several questions. Should a border adjustment tax be considered a protectionist policy? What position would the World Trade Organization take on this point? How would the United States' trading partners react to it? Those in support of the measure argue that, in fact, a border adjustment tax would be similar to a value-added tax (VAT), as applied in many countries (e.g. in Europe). Yet, one way in which a border adjustment tax would differ from a traditional VAT is that it would not apply to income from sales of domestic products.



As recently highlighted by Martin Feldstein, Professor of Economics at Harvard University and a proponent of the border adjustment tax, the effect on exports and imports would be mitigated, or indeed completely eliminated, by a likely adjustment in the US exchange rate in this scenario. In fact, a border adjustment tax would make US exports to the rest of the world more competitive (less expensive), while making imports from the rest of the world less attractive (more expensive) for US consumers. It would therefore increase global demand for the US dollar and would reduce, all else being equal, global demand for other currencies. This should cause the dollar to appreciate, which would cancel out, at least in part, the competitive advantage obtained by the border adjustment tax.



Nonetheless, even in the extreme case where a border adjustment tax would have no effect on exports or imports because of the adjustment in exchange rates, it would not be neutral from a fiscal perspective. In the United States, imports currently exceed exports, which suggests that, if a border adjustment tax were to be introduced, the tax revenue generated from imports should exceed the losses in tax revenue from exports. The Tax Policy Center estimates the additional tax revenue that could be obtained over a ten-year period to be close to a trillion dollars.



Another measure that could generate significant tax revenue in the short term consists in offering US companies an incentive to repatriate the cash they currently hold overseas for tax reasons (estimated at USD 2.5 trillion). An example of such an incentive could be a reduced rate of tax of around 10% on cash brought back to the United States.



The appeal of measures to raise tax revenue is clear, as the large-scale fiscal stimulus considered by the President should significantly increase the budget deficit. At 35%, the US corporate income tax rate is one of the highest internationally. It has been suggested to reduce this rate to 20% or even 15%, which would make the US rate one of the lowest in the world. For individuals, lower taxes and a reduction in the number of tax bands have been suggested. Furthermore, the President seems intent on increasing defence spending and making major investments in infrastructure. Incidentally, investment in infrastructure has been advocated by economists across the board for a number of years. Without significant amounts of new tax revenue, US public debt, which is already in excess of 100% of GDP, would rise significantly in the coming years. This was already the case in the wake of the major tax cuts implemented by President Reagan in 1986.


Yves Nosbusch

Chief Economist

BGL BNP Paribas

Published in the Letzebuerger Land on 17 March 2017