04/17/2017

The Border-Adjustment Sleight Of Hand

Veronique de Rugy and Daniel J. Mitchell, Wall Street Journal

With Republicans in control of Capitol Hill and the White House, this should be an opportune time for major tax cuts to boost American growth and competitiveness. But much of the reform energy is being dissipated in a counterproductive fight over the “border adjustment” tax proposed by House Republicans.

The plan calls for dropping the top corporate tax rate to 20% from 35%, while exempting exports and taxing imports. House Republicans have latched onto the border-adjustment tax for a very practical and understandable reason. It supposedly would generate more than $1 trillion of tax revenue over 10 years. That money could finance other parts of their agenda to generate growth, such as replacing today’s onerous depreciation rules with immediate expensing.

Although their intentions are reasonable, this strategy is questionable. Start with the political blunder: Republican tax plans normally receive overwhelming support from the business community. But the border-adjustment tax has created deep divisions. Proponents claim border adjustability is not protectionist because it would automatically push up the value of the dollar, neutralizing the effect on trade. Importers don’t have much faith in this theory and oppose the GOP plan.

Their concerns are legitimate. No country has ever imposed a border-adjusted corporate-income tax, so this is uncharted territory. But many countries have value-added taxes, or VATs, that are border-adjustable, and their experience might serve as a reasonable proxy. A review of the empirical literature shows that currencies adjust when a VAT is applied, but they do so neither entirely nor quickly. Factors such as poor design or improper administration can get in the way.

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The Reagan Tax Cuts Worked

Thanks to "bracket creep," the inflation of the 1970s pushed millions of taxpayers into higher tax brackets even though their inflation-adjusted incomes were not rising. To help offset this tax increase and also to improve incentives to work, save, and invest, President Reagan proposed sweeping tax rate reductions during the 1980s. What happened? Total tax revenues climbed by 99.4 percent during the 1980s, and the results are even more impressive when looking at what happened to personal income tax revenues. Once the economy received an unambiguous tax cut in January 1983, income tax revenues climbed dramatically, increasing by more than 54 percent by 1989 (28 percent after adjusting for inflation).

 

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