Why The Case For A Border Adjustment Tax Relies On A Questionable Assumption

According to President Donald Trumps press secretary, Sean Spicer, Trump is considering a 20 percent border adjustment tax on Mexican imports. Trump is also reportedly considering a 45 percent tariff on imported Chinese goods as well. Trump has also threatened German automakers with a 35 percent tariff on imported automobiles.

While none of these border taxes have officially been implemented, U.S. companies that rely heavily on imported goods are certainly concerned about the potential for costs to skyrocket. Supporters of new border taxes argue that these cost increases will be offset by a stronger dollar as the economies of U.S. trade partners suffer the consequences of the border taxes. However, many economists question this assumption.

Expert Commentary

Increased protectionism will likely result in dollar appreciation, Mikhail Melnik, Ph.D., associate professor of economics at Kennesaw State University, told Benzinga.

Largely, the USD will appreciate because U.S. protectionism will cause economic weakness overseas and underscore the importance of the U.S. as the safe harbor for investment.

However, Melnik believes it is extremely unlikely that dollar appreciation will completely offset rising import costs for U.S. companies.

This will be more like two steps forward and one step back. A full cancellation effect is unlikely, he said.

Joe Brusuelas, chief economist at RSM, agrees that its unlikely that adjustments in the forex market will completely offset the impact of new import taxes.

Brusuelas told Benzinga the United States would need to see a near perfect adjustment which would support [USD] appreciation of 2025 percent for U.S. companies not to be hit by rising import costs. According to Brusuelas, the forex market is going to adjust, but to say [the adjustment] will be stable is in no way connected to empirical reality of financial markets.

Bruseulas calls the border adjustment tax the biggest change since the inception of the tax reform act of 1976.

Trumps border taxes will serve to offset tax income the United States will lose once he implements his planned corporate income tax cuts.

This is not trade policy, its a tax regime, Brusuelas told Benzinga. This will not correct the trade balance Instead of taxing income, the government will now be taxing cash flows.

For investors, the new border taxes could have a major impact on certain segments of the economy.

Brusuelas said the new border tax favors exports over imports, equity over debt, and small and medium-sized enterprise over multinational corporations.

Companies On Radar

U.S. companies that generate well more than half of their revenue overseas include Dow Chemical Co (NYSE:DOW), Intel Corporation (NASDAQ:INTC) and McDonald's Corporation (NYSE:MCD).

Other companies that derive almost all of their income from within the United States could get a big boost from the border tax. Those companies include Wells Fargo & Co (NYSE:WFC), Verizon Communications Inc. (NYSE:VZ) and Kroger Co (NYSE:KR).

Brusuelas believes it would be helpful to U.S. businesses in the oil and retail industries if the border tax were implemented gradually over time. Trump has given no indication about how he plans to proceed with implementation.

So far in 2017, shares of the PowerShares DB US Dollar Index Bullish (NYSE:UUP) are down 2.4 percent.

Image Credit: By Staff of the President of the United States Donald Trump [Public domain], via Wikimedia Commons