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Trump’s Tax Plan and the Dollar

US President-elect Donald Trump wants a "border-adjustment" tax as part of his corporate-tax reforms. But such measures are suitable only for countries that maintain a fixed exchange rate or are in a currency union; for countries with a floating exchange rate, currency appreciation will cancel out any competitiveness gains.

CAMBRIDGE – Now that Donald Trump has been elected President of the United States and Republicans control both houses of Congress, corporate tax reform is coming to America. The package currently being discussed includes two important features: a cut in the tax rate, from 35% currently to 20% or even 15%; and a “border-adjustment” tax, which is typical of a value-added-tax (VAT) regime, but unusual for corporate taxes.

A border-adjustment tax would treat domestically purchased inputs and imported inputs differently, and encourage exports. Corporations would no longer be able to deduct the costs of imported inputs from their taxable income; but, at the same time, their export-sales revenue would not be taxed.

The proposal has generated an intense debate about whether it will improve the US trade balance. Having published our own work on “fiscal devaluations,” we believe that a border-adjustment tax would have minimal prospects for success, and that it could significantly undermine America’s net foreign-asset position.

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