One of the most controversial topics keeping everybody on their toes this time of year is the House Republican plan to implement the Border Adjustment Tax (BAT). It’s deemed a “remarkably good deal” by Republicans and endorsed by the Trump cabinet. The Border Adjustment Tax pushes the protectionist trend of the present American government.
While President Donald Trump first said the proposed plan was too complicated. These days he seems to embrace the idea wholeheartedly. The one fueling the fire was House Speaker Paul Ryan. He ignited fierce debates between economists on both the left and the right.
But what exactly is the Border Adjustment Tax and how does it work? Simply put, the government wants to adjust taxes at the border so imports are taxed at 20%. It also says exports are to be excluded from taxes in the form of rebates. In theory, this sounds okay. The new BAT would revamp the corporate tax code and stimulate domestic production. Companies would no longer be able to reduce their taxable income while deducting their overseas expenditures. Thus, the United States might witness an income boost of $120 billion courtesy of the foreign companies forced to pay this new tax. All fine and well for America, but what are the consequences of such a tax on a world scale?
Another Type of Domestic and International Meltdown?
One doesn’t have to be a genius to calculate the direct impact of the BAT on the subsequent dollar appreciation (DXY +0.25%) that would naturally follow. Currency appreciation is good on paper. However, the real outcome can be easily put into another type of meltdown affecting the U.S. together with the rest of the world.
Opponents of the Border Tax Adjustment warn that a fast dollar appreciation can lead to severe long-lasting economic distortions. And there would probably be large wealth losses along the way. Gita Gopinath, a professor in the economics department at Harvard University describes one such “worst case” scenario. The scholar says that at least four “worst case” scenarios are likely to occur:
- The BAT would force firms exporting to the U.S. to buy more dollars in order to pay the tax. This would eventually lead to a decline in imports.
- The newly-appreciated dollar might dampen the demand for U.S. exports. A decrease that would leave the U.S. trade in a state of imbalance.
- The increased dollar strength could snowball into a self-reinforcing feedback loop. The U.S. holders of foreign assets might feel compelled to sell them. Then, they would repatriate their money home in order to avoid the losses generated by the subsequent exchange-rate movements.
- Foreign companies, especially the ones in dollar-dependent emerging markets will be the big losers if this plan is implemented. The consequences from foreign governments are hard to deduce.
America is Getting Richer, the World Is Getting Poorer
There is a large number of countries which might be affected by the BAT and the dollar appreciation. They would witness a new debt crisis. Many countries already struggle with the payments on their dollar-denominated bonds. The dollar spiking will only cause even more financial disruptions. Small emerging markets can secure a lower interest rate if they issue dollar-denominated bonds. However, they can also become vulnerable to the imminent interest rates’ fluctuations.
Granted, some countries would, at most, experience a very uncomfortable spike in debt-servicing costs. For others, however, the Border Adjustment Tax might equal a new economical full-blown crisis. Let’s take things one by one and see how the BAT can negatively impact emerging markets.
1. Financial Drops Correlated to the Dollar-Denominated Bonds of Some Countries
This area is covered by countries like Jamaica, Belize, Mozambique, Lebanon, and Venezuela among others. If the tax is passed and the dollar appreciates in line with the expectations, these countries would face even higher levels of dollar-denominated debt compared to their GDP.
2. There Might Be Global Disruptions to the Oil Market
Let’s take into account the fact that the U.S. is still dependent on the crude oil imports, together with other large emerging market consumers such as India or China. On the other hand, emerging markets exporters, such as Russia might want to find other exporting markets to avoid the BAT. Other developed foreign suppliers such as Canada, Mexico, Saudi Arabia and others might also feel compelled to search for alternative markets. In a perfect snowball effect, the BAT together with the dollar appreciation and the shifts in the oil stock market might lead to negative impacts upon refined fuels. America might find itself in the position of buying petrol with a 20% tax added to the price, which simply translates into refined products’ higher prices hitting the domestic consumer directly.
3. Disruption of Trade
It is likely that foreign currencies won’t depreciate to fully offset the BTA rate. This would be turning the BTA into an extra trade tariff. Economies with larger shares of exports directed to the U.S. are thus the most likely to suffer. Factor in the normal competitiveness that would arise between U.S. exports and emerging markets’ exports and you can get a clear picture on how global trade might see the effects. Mexico, Taiwan, Malaysia, Thailand, South Korea, Croatia, Serbia, Kyrgyz Republic, Ukraine, Czech Republic, Hungary, and Poland are just a few emerging markets that are likely to suffer due to the BAT.
4. Tighter International Financial Conditions
The U.S. dollar is the most dominant currency in the world trade. As the dollar rises due to the implementation of the Border Tax Adjustment, emerging markets might face tighter global financial conditions. Sovereign countries dealing with large external financing might find themselves in trouble. If we think about large current-account deficits, emerging markets such as South Africa, Turkey and Colombia would have hard times ahead of them.
5. Global Supply Chain Disruptions
Simply put, the BTA encourages corporations to relocate their production facilities back to their countries. Besides the impact on globally integrated production lines and supply chain systems and logistics, this would cost American companies millions of dollars, as relocation cannot happen overnight and surely American corporations have to legally and financially reach some closure in the countries they are leaving from. This takes a lot of time, money and human resources to achieve and some domestic companies might learn that it costs more to relocate back home than continue production overseas.
6. Foreign Direct Investment Disruptions
There are U.S. corporations which have invested money in emerging markets like no others. Now force these corporations to leave and abandon their investments (building and people being the tip of the iceberg). Firing workers, closing down production facilities, moving stocks and paying local state taxes and debts, facing lawsuits (which almost always ensue after mass layoffs), paying workers’ compensation and starting all over again back home may be a burden even huge American corporations might have troubles dealing with. Now imagine emerging markets having to deal with a sudden boost in unemployment, income shortage, and state taxes shortage to name just a few and you will understand why countries such as Mexico, Thailand, Taiwan, Hungary, Brazil, Romania or China might oppose the Border Adjustment Tax.
While the Border Adjustment Tax is still a plan and not a fact, economy specialists are keeping their eyes wide open, together with developed countries’ governments and emerging markets’ finance experts.
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