A case for a border-adjusted tax: not as bad as you think.

Author:Sinn, Hans-Werner

The new U.S. President shocked German car manufacturers with his statement that a 35 percent tariff will be levied on U.S. imports. On closer inspection, however, the proposal is less outlandish than it may at first appear. For the 35 percent is presumably not meant to be understood as an import tariff, as many people think, but as part of a new form of taxation reminiscent of the value-added tax system. The United States has already largely exhausted the options for tariffs that can be levied within the General Agreement on Tariffs and Trade. It can hardly raise the current average import tariff of around 2.5 percent any further. And leaving GATT and the World Trade Organization would be a risky undertaking even for a daring business leader like Donald Trump.

What Trump's announcement may mean is more of a border adjustment mechanism within a new tax on the real cash flow of enterprises. Such a tax has a long history dating back to 1970s and earlier periods. It was put forward in 2016 as a substitute for the corporate income tax by Paul Ryan, the Republican Speaker of the House of Representatives, presumably after consulting Trump.

The real cash flow of a company is defined as its domestic sales revenues minus expenditure for domestic intermediaries, wages, and investments. Compared to the United States' current taxation system, the taxation of cash flows primarily means that an immediate write-off of investment expenditure is introduced, while debt interest is no longer tax-deductible. Moreover, there is a border adjustment in that profits from exports remain taxfree, while profits from the further sale of imported goods to consumers are subject to tax and imports are not tax deductible. Domestic tax will therefore also be levied on foreign value added, while the domestic value added present in export goods remains tax-free.

This border adjustment is urgently necessary if the ultimate goal is to mimic a tax on domestic consumption by combining a wage income tax with a cash flow tax. This is the explicit aim of those who support a cash flow tax. Critics claim that this border adjustment represents discrimination against imports as opposed to domestic production. This, however, isn't really the case, as the cash flow tax inherently means that domestic tax is only levied once on domestic and foreign added value. It is tme that the full tax rate--probably even less...

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