FairTax Overview
of World War II to 4 percent today. The average import duty on goods in the U.S. is currently 1.7
percent.
Today, the 29 of 30 OECD countries have enacted border-adjustable tax regimes. America stands
nearly alone as the sole developed economy, which refuses to adopt a border-adjustable tax system. The
European Union 15 has an average standard VAT of 19 percent, and the average OECD standard VAT
is 18.5 percent. During the 1990s, Mexico and Canada increased composite rates to 15 percent from 10
percent and 7 percent, respectively, and China adopted a 17-percent VAT in 1994. As foreign
governments have increased the VAT, they have also reduced effective corporate income taxes.
Meanwhile, high U.S. corporate tax rates today coupled with our custom of taxing the foreign income of
corporations based in the states causes the flight of corporations' headquarters to countries that exempt
taxation of overseas income. In effect, the U.S. tax system is distorting the international marketplace
and literally driving plants and good jobs out of this country at a devastating and unsustainable pace.
There are, after all, only so many assets we can sell to foreigners before the entire financial system
enters into a severe crisis.
Some economists mistakenly argue that if America adopted a border-adjusted tax system, any relative
price change would be eliminated by an offsetting appreciation in the dollar. If the FairTax were
implemented, for example, they hypothesize that the price change would be offset by a 23 percent
immediate appreciation in the dollar. The appreciation in this case, they contend, would be caused by a
reduction in U.S. demand for foreign currency to acquire (the now more expensive) foreign goods and
an increase in foreign demand for U.S. currency to acquire (the now less expensive) U.S. goods.
However, the arguments are dubious. The problem with that logic is that the demand for U.S. dollars is
not limited to the traded-goods market. Nearly $90 trillion in U.S. assets owned by households and nonfinancial businesses are denominated in dollars. Financial institutions trade trillions of dollars in
securities and currency each day based on expectations and guesses. Furthermore, the non-traded goods
and services sector is also denominated in dollars and exceeds the traded-goods sector in size.13 A study
by Professor Jim Hausman of the Massachusetts Institute of Technology is helpful to understanding this
problem. 14
13
If, however, these economists are right and there is no increase in the competitiveness of U.S. goods because of a 23percent increase in the price of the dollar (more or less precisely) relative to foreign currency, then that means the FairTax
will have succeeded in increasing the wealth of the American people by something on the order of $20 trillion (23 percent of
$90 trillion) relative to the rest of the world, an instantaneous increase nearly equal to the value of all the goods and services
produced in the U.S. over two years. That would be reason enough to enact the FairTax. Unfortunately for American asset
owners, it is impossible for the traded-goods sector to dominate the currency movements, since the dollar-asset markets are
perhaps 100 times as large as the annual traded-goods market (net basis). See B. 100 and B. 102, Flow of Funds Accounts,
U.S. of America, Fourth Quarter 2004, Federal Reserve System, for statistical information on asset markets.
14
Professor Hausman found:
1. That the existing disparity in treatment of corporate income taxes and VATs for purposes of border adjustment leads
to extremely large economic distortions.
2. That U.S. exporters typically bear both domestic income taxes and foreign VATs in selling abroad.
3. That foreign exporters in countries relying largely on VATs typically receive a full rebate of such taxes upon export
to the U.S., and are not subject to U.S. corporate income taxes.
4. That this situation creates a very significant tax and cost disadvantage for U.S. producers in international trade with
significant impact on investment decisions – leading to the location of major manufacturing and other production
facilities in countries that benefit from current rules on the border adjustment of taxes.
5. That elimination of the current disparity in WTO rules (by eliminating border adjustment for either direct or indirect
taxes) would increase U.S. exports by 14 to 15 percent, or approximately $100 billion based upon 2004 import
levels.
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