by Brad Houle, CFA, Executive Vice President

For the week, the equity markets were higher by about 1.25 percent as investors absorbed Janet Yellen's testimony to Congress and the stronger-than-expected economic data that was posted. Interest rates were higher with the 10-year U.S. Treasury climbing in yield from 2.39 percent to 2.42 percent.

Border Adjustable Tax Basics

A Border Adjustment tax has been in the news as part of a potential broader tax reform for both corporate and individual taxes. A border adjustable tax is structured to tax goods on where they are consumed as opposed to where they are produced. At its core, this tax structure will tax imports and subsidize exports. The key reasons that this plan is being considered are the following:

1. This tax is thought to increase revenue and to allow for a reduction in the current corporate tax rate

2. American companies would be incentivized to manufacture goods in the United States and export goods to other countries which would in theory bring manufacturing jobs back to the U.S.

3. Companies would be incentivized to remain U.S. domiciled companies which is contrary to the recent trend of U.S. companies moving to more tax friendly countries

There are potential winners and losers in this proposed tax change. Companies that import goods to sell would see their costs rise due to a tax that would be levied on all imported goods. Retailers have been vocal critics of this potential change as many retailers sell mostly imported goods. Potential winners are companies like Boeing which manufactures airplanes in the U.S. and exports them abroad.

In theory, if there is a border adjustable tax of 20 percent the cost of an imported good will go up 20 percent and the dollar would appreciate by 20 percent to even things out. Said differently, a U.S. consumer’s dollar in this scenario would increase in value to offset the increase in the price of the good. However, the currency markets don't always behave according to economists’ models. Some of the potential unintended consequences are 1) that the strong dollar could hurt emerging markets countries with dollar-denominated bonds and 2) as a country we still import a significant amount of oil from other countries and this tax would potentially raise the price. In addition, it is theorized that if imported goods go up materially in price then this change could increase the rate of inflation.

This is a risky change in tax structure that could have unintended consequences on our domestic economy and the world economy. With the fortunes of many businesses greatly impacted positively and negatively by this potential change, it seems unlikely that it would be put into practice.

Our Takeaways for the Week:

  • Markets were positively impacted by Yellen’s testimony to Congress
  • A border adjustable tax would tax imports and subsidize exports. Due to its complexity and some potentially unintended consequences, we believe it is unlikely to be put into law