The international competitiveness of the United States has been a topic of heated debate in recent years. In this debate it has been argued that the decline in performance of U.S. firms stems, at least in part, from problems with the federal tax system. In support of these claims, comparisons are often made between provisions of the U.S. tax code and those of the nation's trading partners—with selected differences offered as explanations for unsatisfactory outcomes. The United States reliance on direct taxes (such as income and payroll taxes) is commonly argued to provide a disadvantage when trading with countries that have indirect taxes (such as a value-added tax or VAT). This follows from the allowance in the General Agreement on Tariffs and Trade (GATT)—the predecessor of the World Trade Organization (WTO) agreements—for border tax adjustments on indirect taxes, but not for direct taxes. Almost since its inception in 1967 this provision has been cited as a source of competitive disadvantage and as being an export subsidy. According to this argument, U.S. companies are at a competitive disadvantage because they cannot make use of border tax adjustments like many of their international competitors. Beginning in the Johnson Administration, border tax adjustments have been a matter of concern. In addition, Congress has also instructed U.S. trade negotiators to address this perceived distortion as part of granting fast-track trade authorization in 1974, 1988, and 2002. Congressional interest in this debate continues today with the introduction of the Border Tax Fairness Act ( S. 1043 ) and the Border Tax Equity Act of 2009 ( H.R. 2927 ). In addition to directing U.S. trade negotiators to address this perceived distortion, the acts would impose taxes on imports from countries with border tax adjustments and compensate exporters for border taxes paid. Some assert that these provisions would redress issues of U.S. competitiveness—by offsetting the impact of border tax adjustments on U.S. goods. Others maintain this is not the case. Economists have long recognized that border tax adjustments have no effect on a nation's competitiveness. Border tax adjustments have been shown to mitigate the double taxation of cross-border transactions and to provide a level playing field for domestic and foreign goods and services. This is not to say, however, that a nation's tax structure cannot influence patterns of trade or the composition of trade, through differences in the relative prices of high- and low-tax goods and services. This report explains these common economic findings on the effect of border tax adjustments on international competitiveness through a dual-channel approach—first through analogy to the retail sales tax and secondly using economic theory. As a prelude to these explanations, the report begins with a brief explanation of VATs and border tax adjustments. Hence, in the absence of changes to the underlying macroeconomic variables affecting capital flows (for example, interest rates), any changes in the product prices of traded goods and services brought about by border tax adjustments would be immediately offset by exchange-rate adjustments.
U.S. international competitiveness has been a topic of heated debate in recent years. In this debate it has been argued that the decline in performance of U.S. firms stems, at least in part, from problems with the federal tax system. In support of these claims, comparisons are often made between provisions of the U.S. tax code and those of the nation's trading partners—with selected differences offered as explanations for unsatisfactory outcomes.
One common argument made by advocates of this position is that the United States' reliance on direct taxes (such as income and payroll taxes) provides a disadvantage when trading with countries that have indirect taxes (such as a value-added tax or VAT). This argument follows from the General Agreement on Tariffs and Trade (GATT) allowance for border tax adjustments (the rebate of indirect taxes on exports and the imposition of indirect taxes on imports) on indirect taxes, but not for direct taxes. According to this argument, U.S. companies are at a competitive disadvantage because they cannot make use of border tax adjustments like many of their international competitors.
Almost since its inception in 1967, this provision has been characterized as an export subsidy and as a source of competitive disadvantage. Beginning in the Johnson Administration, high-level discussions have been held concerning this matter. In addition, Congress has also instructed U.S. trade negotiators to address this perceived distortion as part of granting fast-track trade authorization in 1974, 1988, and 2002.
Congressional interest in this debate continues today with the introduction of the Border Tax Fairness Act (S. 1043) and the Border Tax Equity Act of 2009 (H.R. 2927). In addition to directing U.S. trade negotiators to address this perceived distortion, the acts would impose taxes on imports from countries with border tax adjustments and compensate exporters for border taxes paid. Some assert that these provisions would redress issues of U.S. competitiveness; others maintain this is not the case.
Economists have long recognized that border tax adjustments have no effect on a nation's competitiveness. Border tax adjustments have been shown to mitigate the double taxation of cross-border transactions and to provide a level playing field for domestic and foreign goods and services. Hence, in the absence of changes to the underlying macroeconomic variables affecting capital flows (for example, interest rates), any changes in the product prices of traded goods and services brought about by border tax adjustments would be immediately offset by exchange-rate adjustments. This is not to say, however, that a nation's tax structure cannot influence patterns of trade or the composition of trade.
This report explains these common economic findings on the effect of border tax adjustments on international competitiveness, through two perspectives on the issue—first through a discussion on the neutrality of border tax adjustments with respect to cross-border trade and secondly using economic theory to explain the effect of border tax adjustments on the U.S. balance of trade. As a prelude to these explanations, the report begins with a brief explanation of VATs and border tax adjustments.
This report will be updated as legislative events warrant.