Fulfillment of President Donald Trump’s election campaign promises, as well those of Republicans, would revolutionize the American economic policy for the forthcoming years. Moreover, the USA’s global position may cause the protectionist elements of their trade policy to actually improve the country’s economic condition. A commentary from Marcin Lipka, Cinkciarz.pl senior analyst.
Lower taxes for households would be a positive impulse for consumption, as well as for savings. Moreover, a reduction of fiscal burdens for companies may encourage them to invest more as well as support innovation. The concept of the limits in regulation demands for the mining industry would increase the likelihood of the USA’s energetic independence. An improvement of infrastructure should sustain, or even increase, the American economic potential thanks to the above mentioned reform.
However, changes in calculating taxes regarding export and import may be the real revolution of the Republican’s plan. They would cause an immediate improvement in the competitiveness of American products abroad, as well as decrease the attractiveness of import. Moreover, many supporters of this solution claim that it will also contribute to an increase in the dollar’s value.
Border adjustment tax
The current American tax system is the same for both exporters and importers. When their income is at the level of 100 dollars, costs are at the level of 60 dollars and profits are at the level of 40 dollars, and their tax is at the level of 35% (14 dollars). This gives a net profit at the level of 26 dollars.
Lower taxes (from 35% to 20%) and the project of the border adjustment tax, (both included in the Republican plan known as “A Better Way”) would make a company which has sold its product with the use of the foreign components increase its profit to the level of only 20 dollars using the above mentioned example. However, a company which exports products based on the local components will gain profits at the level of 52 dollars (source: Tax Foundation). How is this possible?
The border adjustment tax would change tax foundations and would allow exporters to receive a discount. A company which uses imported components will pay the tax from its total income (20% of 100 dollars = 20 dollars) instead of only from its profits (20% of 40 dollars = 8 dollars). However, exporters would not only be free of taxes, but would also receive a 12 dollar discount (20% of export costs). Therefore, their net profit is 52 dollars.
The above elements should immediately cause dramatic changes in competitiveness of the American goods and services in the world. However, they would clearly decrease import’s attractiveness, which should rapidly reduce the foreign trade deficit. The dollar’s strengthening may be a basic effect of these actions. This would allow for the avoidance of an increase in imported goods prices.
To kill two birds with one stone
The border adjustment tax has a few advantages, which are consistent with the political campaign slogan, “America First.” Apart from supporting export, it definitely reduces the attractiveness of transferring economic activity abroad. Moreover, it could also attract capital to the USA.
It’s also worth emphasizing that this program is consistent with the idea of obtaining global profits from the American companies (2.6 trillion dollars, according to Congress). The return of these funds to the USA would be a subject to a preferentially low tax rate (less than 10%).
One of the most significant flaws of the border adjustment tax is an increase in import prices. However, supporters of this solution (including Martin Feldstein, an economics professor at Harvard University and a retired chairman of the National Bureau of Economic Research) claim that this will cause the dollar’s value to increase 25%.
If the above mentioned scenario is fulfilled, positive results for exporters, as well as negative results for importers, will begin to disappear. However, until there is a foreign trade deficit, the American budget will use higher taxed income (a total of discounts will remain lower than incomes, related to changes in basic taxes).
Who will lose?
If the dollar gains less than 25%, American companies that transferred their production abroad will lose. Moreover, some consumers who have become accustomed to foreign products may lose as well. However, countries that have been attracting American investment capital over the past few years may lose the most. This is because they would have to offer much better conditions, or allow the market to depreciate their local currency. Life standard in these countries would deteriorate. Due to a decrease in competitiveness, the entire global economy may suffer.
It’s worth noticing that despite a significant foreign trade deficit (500 billion dollars in 2015), the United States achieved a positive profit balance from direct investments at the level of 300 billion dollars. This surplus may reduce over the forthcoming years due to the reduction of foreign investments, as well as an increase in the dollar’s value.
However, the majority of Americans won’t likely notice the relatively large losses, but they will see positive effects very vividly.
Have your cake and eat it, too
A combination of a pro-export tax policy, lower taxes for both companies and households, and infrastructure investments should rapidly increase life standards in the USA. This would be even more visible, if the dollar’s value increased. Taking into consideration that the above mentioned actions may force relatively rapid rate hikes by the Federal Reserve, this scenario seems very likely.
We also need to emphasize that if other countries had been as protectionist in their actions, this would deteriorate their economic condition. However, the United States is such a significant market participant that producers would strive to meet the new conditions and avoid import. Consumers usually lose due to limits in foreign trade, but they may not notice any changes due to strengthening of the dollar this time. As a result, thanks to its unique global position, the USA can have its cake and eat it, too. This is because others will pay the bill.