NCPA - National Center for Policy Analysis

Should U.S. Imports Be Taxed to Subsidize Exports?

April 21, 2017

The tax debate in Congress has shifted away from simply cutting taxes to restructuring the tax system. There is no shortage of reform proposals, but current initiatives in tax and trade policy are no longer pointing in the right direction.

International Trade: What Goes Around Comes Around. In two recent Wall Street Journal articles, Harvard University's Martin Feldstein endorsed a House Republican plan to impose a new, 20 percent tax on U.S. imports coupled with a 20 percent subsidy to exports, called a border-adjusted tax (BAT). He calculates a net annual revenue gain of $120 billion, enough to fund a cut in the corporate tax rate from 35 percent to 20 percent. This revenue, he claims, would be "paid for by foreign businesses that sell to Americans."

He could hardly be more wrong. It is an illusion to think that any nation's tax policies have the power to divert income from foreigners to domestic residents. If such sleight of hand were thought possible, governments would be constantly adopting policies to outwit each other, thereby condemning the world to unending economic warfare.

There are four categories of error in Professor Feldstein's reasoning. 

Holding Constant What Is Variable. Perfect constancy is an extreme rarity in the world economy. International trade, therefore, is like a mathematical problem with more equations than variables and, strictly speaking, intractable. Some parts of the global economic system are more constant than others, but one has to be very careful when determining what is constant and what is changing. 

According to Feldstein, "Imports constitute about 15 percent of American gross domestic product (GDP), so the 20 percent tax would raise revenue equal to 3 percent of GDP." It is tempting to admire the simplicity of this "static" calculation, but it completely ignores the axiom that when you tax something you get less of it. Not only would a tax cause Americans to substitute cheaper domestic goods for foreign goods, but it would also therefore reduce their total spending. There would be a chain reaction of consequences for prices in foreign and American markets, as well as feedback loops between U.S. spending, income, output and employment. Thus the revenue raised from this tax would be less than 3 percent of a reduced GDP.

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