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.
The idea of using fiscal-policy instruments to improve trade competitiveness dates back to John Maynard Keynes. In his 1931 Macmillan Report to the British Parliament, Keynes proposed that an import tariff be paired with an export subsidy, which would mimic the effects of exchange-rate devaluation, while maintaining the gold-pound parity. In our own work, we have demonstrated that, in addition to this policy combination, countries that maintain a fixed exchange rate or are in a currency union can achieve the same effect by raising their VAT and cutting payroll taxes by equivalent amounts. This tax-swap policy has received a lot of attention in the eurozone, with Germany implementing it in 2006, and France in 2012.