Report Finds Currency Theory Behind Border Adjustment Tax Dangerously Flawed

"The new border adjustable tax is a dangerous and untested proposal built upon deeply flawed economics. The report shows the inevitable harm it will cause American families and businesses and it should give pause to lawmakers considering taking such a gamble with America's economy," said Brian Dodge, senior executive vice president for public affairs.

Available Empirical and Anecdotal Evidence Casts Doubt on Basic Exchange Rate Theory

The report, authored by economists Paul Ashworth, Justin Chaloner and Glyn Chambers, takes aim at the argument made by backers of the border adjustment tax that the policy will lead to a significant appreciation of the dollar, offsetting the impact on U.S. businesses and consumers.

Auerbach and Holtz-Eakin - "Border adjustments do not distort trade, as exchange rates should react immediately to offset the initial impact of these adjustments." (Alan J. Auerbach, Douglas Holtz-Eakin, 11/30/16)

However, the report authors reject this premise, and found that any currency adjustment would fall far short of offsetting the harmful impact on American consumers.

"The notion of the border adjustment tax causing dollar appreciation is based on a simplification of currency markets, which are highly complex. The proposed measure has not been tried in any other country and there are many issues that pose a large number of questions as to what the consequences would be. Available empirical and anecdotal evidence casts doubt on basic exchange rate theory. Multiple barriers to adjustment plus the fact that traded goods and services only have a limited – possibly small – influence in determining exchange rates in today's world of speculative capital flows means that we expect that most of the proposed appreciation is likely to fail to occur. Some adjustment could occur, but, given the considerable obstacles, we expect it to be no more than 30 per cent of the anticipated total, and it could well be a good deal less than that."

Exchange Rate Doubts So Substantial BAT "Not Worth The Risk of Attempting It."

Further, the report finds that the economic theory behind the dollar appreciation argument to be so unreliable that it is unlikely that currencies will adjust as predicted even in the long term.

"There are substantial reasons for believing that [full currency appreciation] will not occur, especially in the short run, but even over medium to long run timeframes and therefore it is not worth the risk of attempting it."

Because Dollar Will Not Appreciate as Backers Predict, "Border Adjustment Tax Will Amount to a Tax on Consumers."

"…retail markets are likely to experience the kinds of pass through rates seen in competitive markets. This means that the proportion of the expected exchange rate appreciation that does not occur (which we expect to be 70 per cent or more), which is the proportion of the tax that is passed onto American importing firms, is then likely to be passed on to ordinary consumers.

"Due to these likely price increases, the border adjustment tax will amount to a tax on consumers. It will have the effect of raising consumer prices, which will reduce real incomes and in turn living standards. Moreover, as with any tax on spending, it is probable that the impacts will be regressive in nature. That is, poorer consumers, who tend to save a lower proportion of their income and spend proportionately more, will be the hardest hit from the price rises stemming from the tax."

BAT Backers' Assumptions Are "A Gross Simplification of the Complexity of Today's Currency Markets"

"…the confusing literature on exchange rate determination suggests that any exchange rate offset from border adjustment isn't as predictable or as clear-cut as its proponents suggest because basic textbook theory is, at best, a gross simplification of the complexity of today's currency markets. Given the large redistribution of wealth from importers to exporters that would happen in the absence of exchange rate adjustment and the many economic ramifications that could result from that, the policy is, at the very least, highly risky."

About Capital Economics:

Capital Economics is a leading independent international macro-economic research consultancy, providing research on Europe, the Middle East, United States, Canada, Africa, Asia and Australasia, Latin America and the United Kingdom, as well as analysis of financial markets, commodities and the consumer and property sectors.

About RILA

RILA is the trade association of the world's largest and most innovative retail companies. RILA members include more than 200 retailers, product manufacturers, and service suppliers, which together account for more than $1.5 trillion in annual sales, millions of American jobs and more than 100,000 stores, manufacturing facilities and distribution centers domestically and abroad.

SOURCE Retail Industry Leaders Association

Related Links

http://www.rila.org