Is the border adjustment tax a good idea?

Probably not, so say Fichtner, de Rugy, and Michel, here is one bit:

The efficiency claims of proponents rely on several key assumptions that are required for the tax to be non-distortionary. Mainly, the border adjustment must be implemented completely, and international currency markets must fully adjust. For example, the US dollar would need to appreciate by 25 percent to offset a proposed 20 percent import tax and export subsidy.

The academic and policy debate on DBCFTs is generally fragmented, overly confident, and lacking in evidence, as there are no real-world examples of a destination-based cash flow tax. In this paper, we explore just a few of the most pressing questions that threaten to undermine the theoretical benefits of such a reform. Given the uncertainty and large downside risk to a DBCFT, we conclude that the proposal is not yet ready to be implemented and policymakers should focus on more traditional and straightforward reforms.

There is additional concern that the proposed reforms, as currently understood, would not meet the trade neutrality standards of the WTO.

And this:

…the preponderance of evidence seems to show that currencies don’t adjust as theory would predict. Two academic analyses show that VATs do alter international trade by reducing trade volumes, contrary to standard economic models that predict no effect on trade flows. Real-world imperfections in the design and implementation of VATs, such as imperfect border adjustments, are likely to fall more directly on traded goods over others. In a higher-level analysis, Rogoff explains “the extent to which monetary models (or indeed, any existing structural models of exchange rates) fail to explain even medium-term volatility is difficult to overstate.” The economics profession’s understanding of exchange rates is so “mediocre” that our models fail to outperform random walk models—a model that assumes we can’t predict the future.

Since the DBCFT was proposed, many private-sector analyses have supported the academic literature that finds currencies do not always fully adjust. Morgan Stanley research expects that a DBCFT would have a significant impact on foreign exchange markets. It concludes that the dollar could appreciate by 10 to 15 percent, but that real-world frictions and uncertainty around WTO eligibility would keep exchange rates from fully adjusting. Citigroup research projects a 14.6 percent rise in the real effective exchange rate three years after DBCFT implementation, finding that “slow real exchange rate adjustments are the historical norm.”

Proponents who claim that DBCFTs do not effect domestic savings-to-investment decisions are at odds with others who describe the proposal as a consumption tax.

Here is the full piece.


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