February 11, 2017
This is really getting over the top. Republicans in Congress are debating an overhaul of the corporate income tax which would eliminate many of the opportunities for gaming the current tax code. To my mind this is great news, because the tax-gaming industry is where many of the richest people in the country, like private equity fund partners, make their money.
This means that the current corporate tax code is a mechanism for transferring money from the rest of us to the likes of Mitt Romney and Peter Peterson. It’s understandable that these people would be very upset by a plan to end their tax-gaming windfalls, but why is Neil Irwin at NYT so upset?
The story he pushes is that border adjustability rules in the proposed reform would create enormous disruptions in the economy because it would lead to a sharp rise in the value of the dollar. Irwin tosses around a hypothetical 25 percent increase in the value of the dollar which he warns:
“…could shift trillions of dollars of wealth from Americans to foreigners; set off an emerging markets financial crisis; wreak havoc in global oil markets; and cause sustained harm to the American higher education and tourism industries (including, as it happens, luxury hotels with President Trump’s name on them).”
Okay, this is more than a little bit silly.
Let’s start with the 25 percent number. The idea is that the dollar would rise enough to leave our trade balance more or less unaffected even though we have imposed the tax on all imports and refunded it on all exports. So if we were talking about a tax rate of 25 percent on both, this sort of increase in the value of the dollar would leave the price of U.S. imports unchanged to people in the United States and the price of U.S. exports unchanged for people living in other countries.
The first problem with this story is that we’re not talking about a 25 percent tax, the number most often floated is 20 percent. Furthermore, the amount rebated on exports would be a small fraction of this number since the tax is not assessed on wages, interest or dividend payments, or profits that are reinvested. This likely means that the tax would be in the range of 1 to 2 percent of the final price of the product.
If we assume that the dollar fully adjusts to leave our trade balance unchanged and we split the difference between a 2 percent fall in the price of our exports and a 20 percent increase in the price of imports, we are looking at an 11 percent rise in the value of the dollar. If we assume that the adjustment is less than 100 percent, say something like 75–80 percent, then we would be looking at a rise in the value of the dollar of 9.0 percent.
If this sort of increase in the value of the dollar would lead to a financial crisis in emerging markets, then we should be seeing one now, because the dollar has risen by roughly that amount against the currencies of our trading partners since last spring. If there has been a crisis the NYT has neglected to cover it.
Movements of this size happen all the time. They certainly can cause problems, but the financial system generally deals with it.
The global oil markets comment is especially annoying because it repeats the ridiculous line about it being important that oil is priced in dollars. It isn’t. The pricing in dollars is simply a convention. It is like we were writing the price of oil up on a chalkboard. We need a unit in which to measure the price. It could be euros, it could be yen, it could be bushels of wheat. Due to the dominance of the U.S. economy, the tradition has been to use dollars.
As a practical matter, oil is traded in whatever currency is convenient for the trading partners. Most often this is dollars, but it can be other currencies if the two parties choose. Also, if the price of the dollar rises against other currencies, then the dollar price of oil will typically fall. The exception will be in situations where companies have signed long-term contracts specified in dollars. In this case, the buyer will take a hit and the lender will get a windfall.
In this context, a 9 percent rise in the value of the dollar matters, but nowhere near as much as the sixty percent drop in the price of oil between 2014 and 2016 or even the 25 percent increase in the price of oil between the summer of 2016 and end of the year.
As far as the impact of the 9 percent rise in the value of the dollar on U.S. higher education, well life is tough. The same is true for our tourism industry (including the U.S.-based Trump hotels — the foreign ones benefit). They can console themselves with the fact that the hit is smaller than what they just endured over the last eight months.
The basic story here is that this tax reform offers the opportunity to eliminate a major channel through which income is transferred from the rest of us to the very rich. We will have to see the real life legislation to pass judgement. But anyone who doesn’t work for the private equity boys and the rest of the tax shelter industry should be happy to see Republicans in Congress considering something along these lines. It should not be shot down for bogus reasons.
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