In late December, we explained why of all Trump economic proposals , the “border tax adjustment“, while most controversial, could have the biggest impact on US assets.
As a quick refresher, the proposal would tax US imports at the corporate income tax rate, while exempting income earned from exports from any taxation. The reform would closely mirror tax border adjustments in economies with consumption-based VAT tax systems. If enacted, Deutsche Bank predicted that the plan would be especially bullish for the US dollar, sending it higher by as much as 15%. What’s more, it would have a transformational impact on the US trade relationship with the rest of the world. Consider the below:
A ‘border tax adjustment’ would, roughly speaking, be equivalent to a 15% one-off devaluation of the dollar. Imports would be 20% more expensive, because corporates would have to pay the new 20% corporate tax rate on their value. Exports would be roughly 12% ‘cheaper’, because for every $33 of earnings earned from $100 of exports (we use the 33% gross margin of the S&P), there would be a 12% tax cost ($33 earnings*35% current tax rate) that would no longer be imposed on corporates. Taking the average impact on the prices of exports and imports is equivalent to a 15% drop in the dollar. A border tax adjustment would be very inflationary. The price of exports doesn’t affect the US consumption basket so would have no impact on CPI. However, the cost of imports would go up by 20%, which based on a simple relationship between import PPI and US inflation would be equivalent to a 5% rise in the CPI. Corporates may of course choose to absorb part of the rise in import costs in their profit margins. But either way, the order of magnitude is large.
This post was published at Zero Hedge on Jan 13, 2017.