January 13, 2017

Make the "Better Way" Even Better
Add Exchange Rate Reform


                                                                                                                                                     John Hansen

Today we propose a new tax code built for growth -- for the growth of paychecks, for the growth of local jobs and economy, and the growth of America’s economy.”           
Kevin Brady

With these words, Representative Brady, as Chair of the Ways and Means Committee and leader of the Tax Reform Task Force, unveiled A Better Way for tax reform.

The Better Way notes that a Made in America Tax (MAT) puts American-made goods and services at a severe competitive disadvantage. The MAT exists because U.S. exports face two tax burdens not borne by the exports from most foreign countries: First, made-in-America goods must compete in U.S. markets with imports that are not similarly taxed. Second, when U.S. goods are shipped to foreign markets, they must pay the VAT charged by those countries.
To fix the Made in America Tax problem, the Better Way plan suggests a border-adjustable tax (BAT) that would exempt American exports from paying the “company tax” proposed in the Better Way to substitute for the current corporate income tax. It also proposes that America effectively impose a tariff-like charge on imports from foreign countries based on the company tax rate.
Although the BAT holds considerable promise, it also contains a potentially serious risk. As its proponents, have noted, the border taxes would serve as tariffs. As such, the proposal has been challenged by those concerned that the tariffs would raise the price of imports, hurting U.S. consumers of both finished and intermediate goods. Also, the BAT may conflict with WTO rules.
However, the proponents argue that the tariff effect of the BAT would be offset by appreciation of the dollar, leaving no net change in the dollar cost of imported goods to consumers.  This is sound thinking according to economic theory. However, this exchange-rate / tariff offset raises two other concerns. First, why are we considering a measure that will make the overvalued dollar even more overvalued? Second, what if the dollar valuation offset to tariffs overshoots the mark.
If the offset mechanism works, at least the dollar’s overvaluation will be no worse than it is today, but on the other hand, the BAT does nothing to make U.S. production more competitive against imports. Furthermore, if the exchange rate rises in line with the BAT rate, the BAT exemption on exports will be offset by the higher exchange rate. 

The Market Access Charge as a Complement to the Better Way

Given these problems with the BAT, I would suggest that, while considering ways to avoid the Made in America Tax, Congress needs to eliminate an even more serious tax on American goods – the overvaluation of the dollar that creates an Overvalued Dollar Tax (ODT). With a Market Access Charge (MAC), the ODT tax can be eliminated in a way that generates revenues that would help finance both a reform of the corporate tax system and the urgently-needed infrastructure problem proposed by the Trump Administration.
Data from the Peterson Institute for International Economics and the Federal Reserve indicate that the U.S. dollar is overvalued by about 35 percent today. Unlike the corporate tax, which is basically a tax on a company’s often small profits, the overvalued dollar tax is a tax on 100 percent of the final selling price of all US goods. Consequently, the Overvalued Dollar Tax can impose a far larger burden on corporate profitability than the corporate profits tax.
The overvalued dollar weakens the competitiveness of American producers both at home and abroad. In the short run, this weakness is often papered over with money borrowed from abroad to cover the deficits caused by America’s booming demand for “cheap” foreign products. But in the medium term, the dollar’s overvaluation makes American producers less competitive, less profitable, less able to maintain U.S. jobs, and less inclined to undertake the investments in real productivity urgently needed for America’s long-term strength and greatness.
The primary cause of the dollar’s massive overvaluation is an excessive inflow of capital from foreigners seeking profits by purchasing dollars and dollar-based assets in America’s attractive financial markets. Most of these flows go into trading that does little or nothing to improve the physical productivity and international competitiveness of America’s manufacturing sector.
Adding a Market Access Charge (MAC) to the Better Way proposal help resolve this problem. A modest MAC would be assessed on foreign capital inflows whenever the dollar was significantly overvalued as indicated by a trade deficit exceeding one percent of GDP. The MAC would reduce net returns to foreign investors ­ especially foreign speculators. With a MAC in place, foreign demand for dollars and dollar-based assets would moderate, and the dollar would gradually move back to its trade-balancing equilibrium exchange rate. Note that foreign traders, not Americans, would pay the MAC charges!

A trade-balancing equilibrium exchange rate would increase domestic and foreign demand for made-in-America goods, accelerate growth, and create more jobs with higher wages. Higher growth would mean larger tax revenues – even if tax rates were reduced as proposed in the Better Way plan. Thus, adding a Market Access Charge to the reform package proposed by Chairman Brady and his task force would make it easier to balance the budget  – while simultaneously increasing critical investments in our nation’s infrastructure and reducing the national debt.

In sum, a Market Access Charge (MAC) would be an invaluable component of the Better Way strategy because it would:
  1. Increase the competitiveness and thus the profitability of U.S. companies – by about three times as much as would a border-adjusted tax.
  2. Move the dollar closer to its trade-balancing equilibrium exchange rate. (The BAT could actually raise the dollar’s value, making U.S. goods less rather than more competitive.)
  3. Stimulate the growth of well-paying jobs throughout the economy and reduce the incidence of poverty in our great nation.
  4. Fix the key underlying problem causing the decline in America’s competitiveness – a seriously overvalued dollar.
  5. Comply fully with WTO, IMF, and U.S. Government rules, laws, and agreements – thereby avoiding the WTO problems that face the border-adjustable tax proposal.
  6. Stabilize the financial sector, thereby reducing the systemic risk of major disasters such as the Crash of 2008. This might even make it possible to reduce the sector’s regulatory burden.
  7. Make important contributions to balancing the budget while providing a solid basis for reducing tax rates significantly, simplifying America’s broken tax code, and improving essential government services. 

For more on the Market Access Charge (MAC) and related issues, see the blog site Americans Backing a Competitive Dollar (www.abcdnow.blogspot.com).

March 23, 2017 (rev.)

John Hansen, PhD          Former World Bank Economic Advisor            hansenj@bellsouth.net
Founding Editor              Americans Backing a Competitive Dollar       www.abcdnow.blogspot.com

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