Daily Times

Taxes are one of life’s certainties, and this year so is business tax reform. The tax plan developed by the House Republicans is similar in many ways to President-elect Trump’s plan but has one additional favorable feature-a border tax adjustment that exempts exports and taxes imports. This would give the US the benefit that other countries obtain from a value-added tax (VAT) but without imposing that extra levy on domestic transactions.

Retailers and others oppose the border tax adjustment because it appears to raise the cost of imported products. But their analysis ignores the increased international value of the dollar-and therefore the lower dollar price of imported foreign products-that would automatically result from the border tax. In the end, the prices paid by US consumers would be essentially unchanged.

To understand how this would work, consider first what would happen if the value of the dollar doesn’t change. Without a border tax adjustment, a US exporter could export a product with a $100 total production cost (including the return on capital) for a price of $100. A retail customer in a country with a 15% value-added tax would pay $115 for that product. But the border tax adjustment would allow the company to deduct the $100 cost of production when it calculates the tax on corporate profits. That would save $20 under the 20% rate House Republicans propose. That $20 tax saving would reduce the price of the exported product to $80. The retail buyer in the country with the 15% VAT would therefore pay $80 plus 15%, or $92.

A US importer that pays $100 to import a product can, if there is no border tax adjustment, sell that product to a US retail customer for $100. But with the border tax adjustment, the $100 import cost is not deductible from the corporate tax base. The price to the US retail buyer would have to be $125, of which $25 would go toward the 20% tax.

These calculations make it look as if the border tax adjustment causes the US consumer to pay 25% more for imported products and the foreign consumer to pay 20% less than they otherwise would. But the price changes that I have described would never happen in practice because the dollar’s international value would automatically rise by enough to eliminate the increased cost of imports and the reduced price of exports.

Here’s why. If the exchange rate remained unchanged, the higher price of US imports would reduce the US demand for imports and the lower dollar price of US exports would raise the foreign demand for American exports. That combination would reduce the existing US trade deficit. But as every student of economics learns, a country’s trade deficit depends only on the difference between total investment in the country and the saving done by its households, businesses and government.