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1 [1] (January 6, 2017)

handle is hein.crs/govceyx0001 and id is 1 raw text is: Bus Border-Adjusted Taxes: APrimer January 6, 2017 The Better Way tax reform blueprint issued by House Speaker Paul Ryan on June 24, 2016, proposed replacing the current corporate and business income tax with a destination-basis cash-flow tax (with some minor modifications). A destination-basis tax is a border- adjustable tax that exempts exports from the tax and imposes the tax on imports. It taxes production consumed in the United States, whereas the current corporate tax is (largely) imposed on income produced in the United States. The most broadly known destination-based consumption tax in the world is the value-added tax (VAT). A VAT that taxes imports and exempts exports is sometimes mistakenly viewed as permitting an export subsidy and an unfair advantage to countries that have them. These border adjustments are irrelevant to any real trade effects in the case of a uniform VAT, which imposes the same rates on all products-that is, it does not affect real imports, real exports, or the trade balance. (Taxes could have other effects unrelated to border adjustments, such as influencing savings or the composition of demand through distributional effects, but these would occur regardless of the border adjustment.) The imposition of a tariff or an export subsidy in isolation, however, does have real effects. See CRS Report R40735, International Competitiveness: An Economic Analysis of VATBorder Tax Adjustments, by Donald J. Marples, for a more detailed discussion of the material presented below. See CRS Report R44342, Consumption Taxes: An Overview, by Jeffrey M. Stupak and Donald J. Marples, for a discussion of consumption taxes generally. Border adjustments can best be explained with a simple equation for the balance of payments. Generally, the balance-of-payments framework holds that if a country maintains a trade deficit, the country must borrow foreign capital to finance the purchase of imports. The balance-of- payments relationship (which says that dollars sold equal dollars bought) is shown in equation (1): (1) P x X - e x Pf x M - P x F = 0 where P is the U.S. price level, Xis the quantity of exports, Pf is the foreign price level, e is the exchange rate relating dollars to foreign currency, M is the quantity of imports, and F is the quantity of net capital outflows and other financial flows for the United States. The value of e is the ratio of the dollar to foreign currency. For example, $1 for Y115 (Japanese Yen) would be 1/115. Although there are many trading partners and currencies, and many products and thus multiple exports and imports, treating these as composites does not change the analysis. This relation reflects the requirement that dollars bought must equal dollars sold. Foreign purchasers must buy dollars to buy exports from the United States. Analogously, U.S. purchasers must buy foreign currency (sell dollars) to buy imports or investments abroad. The demands for exports and imports are dependent on the relative prices of U.S. goods and domestic goods and on the exchange rate, P/(ePf). When the U.S. price rises, exports become more expensive in foreign markets and thus the quantity of X (exports) falls. If foreign prices rise, U.S. exports are more attractive. Imports become more attractive when the U.S. prices rise because imports become relatively cheaper than domestic goods. This relative price is the only price that matters, which can be seen by dividing each term in equation (1) by P to obtain equation (2); the relative price will appear inverted in the equation in the middle term. (2) X - (e x Pf /P) x M - F = 0 The relative price appears in three locations: it determines the demand for exports, it determines the demand for imports, and it determines the price of imports (the inverted price relationship in the second term of equation (2)). The crucial point is that if the relative price Pl(ePf) remains fixed, the balance of payments remains equal to zero with the same quantities and nothing changes. Suppose the United States were to enact a VAT of x% on all goods consumed in the United States, including imports, such that the U.S. price, P, rose by x%. By rebating the tax on goods exported, the price, for the purpose of export demand, is its original pretax level. Thus, the relative price that drives export demand is unchanged. In the case of imports, the U.S. price rises by x%, but at the same time a tax is imposed on the foreign price also at x%, so the numerator of the relative price term rises but the denominator rises by the same percentage. These effects cancel out, leaving the same fixed relationship. The tax on imports has increased the foreign price, for purchasers, by the same percentage as the increase in the domestic price, and imports are no more or less attractive relative to home- produced goods. Suppose the border adjustments were not made. Now the U.S. price level rises by x%, export demand falls, and import demand rises. But these price and demand effects create an imbalance in payments. In response, the exchange rate e will increase (the price of the dollar will fall). For example, if x is 10%, e will rise by 10% (this movement is referred to as dollar depreciation, because it now takes more dollars to purchase a given amount of foreign currency). All that is required to restore the original balance with unchanged quantities is a percentage change in the exchange rate of the same magnitude. p\w -- , gnom goo mppm qq\ , q I 'M 11LULANJILiM,