Tremendous global spillovers. Analysis and mechanisms of the destination based border adjustment tax

The Republican members of the US House of Representatives have proposed a controversial corporate tax reform, the so-called “destination-based border-adjusted cash-flow tax” (DBCFT). This tax would represent a major overhaul of the US corporate tax system and have important economic implications in the US and globally if implemented. Against this background, this paper analyses the mechanics of this new tax, its macroeconomic implications as well as its global spillovers using a global multi-country fully structural model. Scenarios are estimated using a global multi-country fully structural model. The model embodies fully structural demand for imports and tracks bilateral trade in intermediate and final goods. In our baseline simulation, the corporate tax reform would boost US GDP and inflation. There is a significant – but less than complete – appreciation of the US dollar. Moreover, the US trade deficit would decline notably and, overall, global imbalances would diminish. As for global trade, even in the baseline scenario without retaliation, world trade declines substantially and global economic activity spillovers are substantially negative. Countries with large exposure to US trade are hit the hardest. World trade would decline significantly more strongly if a coordinated retaliation against the US border adjusted tax materialises. The macroeconomic implications and global spillovers depend on a number of factors and the paper explores: (1) whether US trading partners retaliate, (2) whether agents consider the new regime to be transitory or permanent, which will be important to determine how the USD exchange rate would respond, (3) to what extent export firms would be reimbursed by tax liabilities related to their domestic costs and (4) how financial markets in emerging economies react. Overall, the tax reform would have re-distributional consequences, creating winners and losers, as the US economy rebalances away from domestic demand towards exports. The DBCFT would reduce consumer welfare as US households face higher inflation and consume less despite having to work harder. This would hit low-income households most strongly, while large export corporations would benefit the most.