Republicans have a plan to cut trillions of dollars in taxes while still having enough money to run the government thanks in large part to what opponents call a new tax on imports.
But the proposal could have costly unintended consequences — especially for the elderly.
Retirees are financially vulnerable to rising prices, or inflation, which is one possible result of the GOP plan. If the proposal sets off inflation, many households would benefit from increasing wages and salaries. Meanwhile, some retirees would pay more at the cash register without the benefit of a fatter paycheck.
Economists dispute exactly what would happen if Republicans put the plan, called a border adjustment, into effect. Many experts say the proposal would not prove inflationary, and others debate by how much prices are likely to increase. Rep. Paul D. Ryan (R-Wis.), the speaker of the House and architect of this “border adjustment” plan, and his colleagues included the idea in a white paper on tax reform last year.
But according to a new report published this week by the nonpartisan Peterson Institute for International Economics, other countries that have implemented border adjustments have often seen inflation follow.
“That could fall heavily on the elderly,” said economist Caroline Freund, who wrote the report along with colleague Joseph Gagnon. “It's a really underappreciated point.”
The pair did not give an estimate of how much inflation a border adjustment would produce, but a substantial increase is possible, given the ambitious scope of the Republican plan.
Among the elderly, households that rely exclusively for retirement on benefits that are indexed to inflation — such as Social Security — would enjoy some protection. Wealthy households would be able to insulate their savings by investing in stocks and other equities. Prices on Wall Street would also climb if inflation picked up.
Those most negatively affected would be households with savings invested in bonds, certificates of deposit and other fixed-income securities. Likewise, those with pensions that are not adjusted for inflation, such as many private-sector defined-benefit pensions, would lose some of the value of their benefits.
“It’s a good time for people to be evaluating their investments,” Freund said. “Inflation has been so low for so long, people may have forgotten that sometimes you need to protect against it.”
Inflation in the United States has been declining for decades, and by one measure, annual inflation has not exceeded 3 percent since 2008. The Republican proposal could reverse that trend.
With a border adjustment, corporations would no longer be able to deduct the costs of imported goods and services from their incomes. At the same time, corporations would not have to pay taxes on income from exports abroad.
Demand for products made in the United States could rise both domestically and around the world.
Domestically, goods and services produced in the United States would become relatively cheaper compared to products from foreign competitors because of the tax on imports. The same would be true of U.S. exports on sale in foreign countries. U.S. producers would seek to hire more workers to meet that demand.
One result could be rapid inflation across the economy.
For example, in the year after New Zealand imposed a 10 percent tax with a border adjustment in 1986, inflation accelerated by seven percentage points, according to Freund and Gagnon's report. A three percentage point jump followed when Australia implemented a similar tax in 2000.
Inflation would eventually cancel out the advantages of domestic products. Although goods produced in the United States would not be subject to tax, the cost of producing them would have increased because of demand.
In the long term, the overall amount that the country imports and exports would be largely unaffected, and although workers would enjoy higher wages, they would also pay more for everything.
In this sense, the new report does not buttress the arguments from opponents of a border adjustment, such as Sen. David Perdue (R-Ga.). He and others have described the plan as a tax on imports that would put a crimp in the economy.
In other countries, however, border adjustments have accelerated economic expansion in the short term, and in the long term, prices for imports have merely increased along with prices for domestic products and wages. Freund and Gagnon find that most of these adjustments occur within three years.
Inflation would not just be a wash, though: Americans and especially the elderly could lose some of the value of their savings.
Proponents say a border adjustment would not be inflationary. Instead, they argue, the price of the dollar would increase relative to other currencies if the plan were enacted. Since American companies' exports would be exempt, foreigners holding dollars could make purchases with them without paying indirect taxes, increasing the value of their U.S. currency.
Similarly, Americans holding other currencies would have to pay taxes on any purchases they made with that money, so those currencies' value would decrease — at least according to this reasoning.
If so, prices for imports and exporters would not change. Importers would have to pay taxes, but they would be able to get more for their money with their more valuable dollars. Exporters would be exempt, but their customers overseas would have to pay more to buy those exports because U.S. currency would be more expensive. Demand for U.S. products and labor would not increase, nor would prices.
“I don’t think prices will go up very much, but even if they did, we’re talking about a short-run adjustment,” said Alan Auerbach, a vocal advocate of a border adjustment and an economist at the University of California at Berkeley. The only Americans negatively affected would be those with investments in foreign countries, because the prices of those investments in dollars would fall.
A rapid shift in the exchange rate would put the brakes on inflation, but just how quickly or how completely the dollar's price would climb in response to a border adjustment is difficult to predict. Although inflation was typical in the historical examples Freund and Gagnon studied, there are reasons to think things might go differently in the United States.
Other countries typically use what are known as “value-added taxes,” which also apply to wages and salaries paid by firms. By contrast, in the GOP plan, firms would not have to pay taxes on their payrolls. Economists say that because of that distinction, domestic prices might not rise under the Republican plan as they have in countries that adopted value-added taxes.
On the other hand, Freund argues, the dollar's price may be held in place by powerful forces other than global trade. Dollars serve as a global reserve currency, and demand for them is strong in financial markets around the world, where they give businesses in different countries a reliable, standard system for making all kinds of deals. As a result, exchange rates might adjust more slowly, resulting in U.S. inflation.
Finally, the scale of the Republican plan is massive compared to similar policies implemented elsewhere. New Zealand and Australia implemented border-adjusted taxes at rates of 10 percent, while the Republican plan calls for a 20 percent rate, and many observers think any reform that is ultimately enacted might impose an even higher tax.
Over the long run, economists say that a 20 percent rate adjusted at the border implies a 25 percent increase in the cost of U.S. goods, services and labor in terms of foreign currency. It is difficult to know how the economy would respond to such a shift. Yet even if most of the adjustment occurs through an appreciation of the dollar and only partially as a result of inflation, the effect on households budgets could be serious.
“That's just such a big number,” Freund said.
The question is crucial to Republicans' overall legislative agenda. They are planning on cutting taxes on businesses and households across the board, so they need some other source of money to keep the heat on in government buildings.
The border adjustment would give Republicans some of the money they need, but the risk of inflation could reinforce opposition to the already beleaguered plan. In February, Sen. John Cornyn (R-Tex.) said the border adjustment was "on life support” — although Republicans still have not put forward an alternative.
White House officials told The Washington Post on Tuesday that the Trump administration was considering other means of raising revenue — among them, a value-added tax. The administration disavowed those proposals later that same day.