FairTax Overview
Many observers – and unemployed or underemployed American manufacturing workers – take
the position that this border adjustment gives foreign firms a large advantage. Since their goods do not
include the full burden of their domestic governments in their prices, while U.S. goods and services do,
some consider this unfair, or at least uncompetitive. Most business leaders would agree. Professional
economists are divided. Some agree. Some argue that foreign exchange rates change in response to
border tax adjustment, and little competitive advantage is provided to imports.32 The flight of U.S. jobs
would appear to provide all-too-real disagreement with this theoretical viewpoint. Others argue that in
the short term, imports (i.e., the traded goods sector) gain an advantage that evaporates over time.33
None argue that failure to reciprocate with a border tax adjustment has an adverse impact on the U.S.
manufacturers, farmers, or service providers.
Interest rates and currency trading are the significant factors in exchange rates; increased
demand for American goods and services is not.
There are many things that affect foreign exchange rates. Expectations about interest rates and inflation
rates in the two countries are the most important. The magnitude of currency traded by banks, other
financial institutions, governments, and private currency traders dwarfs the amount of currency bought
and sold because of international trade. The magnitude of currency trading is vast compared to the small
amount of excess demand caused by the U.S. trade deficit and changes in that deficit. It is, therefore, far
from clear that the changes in exchange rates generated by an increased demand for U.S. goods would
cancel out the improvement in the competitiveness of U.S. produced goods caused by the “borderadjustment” feature built into the FairTax.
A recent study by Professor Hausman found that:
· Existing disparities in treatment of corporate income taxes and VATs for purposes of border
adjustment lead to extremely large economic distortions.
· U.S. exporters suffer both domestic income taxes and foreign VATs when selling abroad.
· 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 taxes when sold here.
· 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.
· The adverse economic implications for the U.S. are very large. Ask someone from Michigan.
· 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.
· Eliminating such economic distortions should be a high priority.
32
See Feldstein, Martin and Paul Krugman, “International Trade Effects of Value Added Taxation,” in Taxation in the
Global Economy, Assaf Razin and Joel Slemrod, eds., Cambridge, Massachusetts: National Bureau of Economic Research,
1990, pp. 263-282.
33
Hufbauer, Gary Clyde and Joanna M. Van Rooij, U.S. Taxation of International Income: Blueprint for Reform,
Washington, D.C.: Institute for International Economics, 1992; Hufbauer, Gary Clyde and Carol Gabyzon, Fundamental Tax
Reform and Border Tax Adjustments, Washington, D.C.: Institute for International Economics, Policy Analyses in
International Economics 43, 1996; Raboy, David G., “International Implications of Value Added Taxes,” in Value Added
Tax: Orthodoxy and New Thinking, Murray Weidenbaum, David G. Raboy, Ernest S. Christian, Jr., eds., St. Louis,
Missouri: Center for Study of American Business/Kluwer, 1989, pp. 131-162.
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