Distributional Implications Of The Border Adjustment Tax For U.S. Households: Lower And Middle Income Households May Be Hard Hit

by: Econbrowser

Recently, Furman, Russ, and Shambaugh (2017) provide evidence that tariffs are a regressive form of taxation, drawing on insights from Fajgelbaum and Khandelwal (2016) and others. Here, I expand on that work to give initial ballpark estimates for the impact of the border adjustment tax on households in different parts of the income distribution. The impact falls hardest on the lower- and middle-income households and the magnitude is considerably greater than the current U.S. tariff schedule imposes.

Will a strong dollar cancel out the effects of the border tax on households?

Some analysts argue that the balance of the tax on imports and the tax break on export sales would strengthen the dollar enough that the border adjustment would not affect the purchasing power of consumers or firms with respect to imports. While the theoretical models are suggestive, this is an open empirical question that would benefit from careful empirical investigation. Were it indeed the case that exchange rate and wage adjustments would fully offset the tax on imports, which no one at present can say with certainty, the general equilibrium responses involved could take at least two years to occur if the existing literature on pass-through in traded goods prices is a guide.

This analysis takes a middle ground. I suppose that frictions impeding general equilibrium adjustments in exchange rates and wages, as well as other factors well known in the pass-through literature, prevent the full general equilibrium responses that would wipe out the impact of the border tax adjustment. I assume that half of the proposed 20 percentage point border adjustment tax is passed into prices paid by buyers of imported goods. True believers in general equilibrium thus might look at this as a short- or medium-term scenario (1-3 years). General equilibrium skeptics might consider it a longer-term scenario.

Estimates of the impact on households per year

The chart below shows one possible range of results given different strategic responses of domestic producers.

The trade literature shows that domestic producers are likely to respond to taxes on imports by raising their own markups and prices. The lower-bounds for the estimates in this chart arise if domestic producers do not raise their prices or markups at all, while the upper-bound assumes that they do so by 5 percentage points (half of the 10 percentage point increase that buyers see in import prices).

The supply side

Embedded in the estimates is a very stylized impact on prices firms face for imported inputs. I assume that firm expenditures on imported inputs are 10 percent of the size of their revenues. These imported input prices rise by half of the border adjustment tax and firms pass this increase in costs into the prices they charge on their own products. This piece of the estimation is more stylized in the sense that it does not take into account either (1) how the import cost share varies across industries importing intermediate goods and their multi-level input-output channels as in Ossa (2015), or (2) the possible impact of price spillovers from the border adjustment tax into the prices that domestic producers of intermediate goods charge U.S. buyers of their products.

How regressive is it?

The impact of the border tax adjustment on the cost of current household consumption bundles is greatest for lower-income households when looked at relative to household income. The chart below shows that even the lower-bound of this impact has the potential to greatly exacerbate the regressivity of the current taxes on imports, showing the estimates assuming zero spillover into the prices of domestically produced goods. The cost of the current consumption bundle has the potential to increase by an amount roughly 2 percent or more for the lowest three deciles of the household income distribution, but roughly 1 percent for the upper three deciles.

For full details of methodology and the matching of the tariff schedule to the Bureau of Labor Statistics Consumer Expenditure Survey, including a discussion of caveats and paths for future research, see Furman, Russ, and Shambaugh (2017).

References

Furman, Jason, Katheryn N. Russ, and Jay C. Shambaugh. 2017. Tariffs are an Arbitrary and Regressive Tax. VoxEU. 12 January. http://voxeu.org/article/us-tariffs-are-arbitrary-and-regressive-tax

Ossa, Ralph. 2015. Why Trade Matters After All. Journal of International Economics. 97(2): 266-277 (November).[working paper version]

Fajgelbaum, Pablo and Amit Khandelwal. 2016. Measuring the Unequal Gains from Trade. Quarterly Journal of Economics. 131: 1113-1180.

Editor's note: This article was originally published on January 29, 2017, by Menzie Chinn here.