Mary Amiti, Oleg Itskhoki, and Jozef Konings

There has been much debate about the proposed border tax adjustment, in which U.S. firms would pay a 20 percent tax on all imported inputs and be exempt from paying taxes on export revenue. The view among many economists, including proponents of the plan, is that the U.S. dollar would appreciate by the full amount of the tax and thus completely offset any relative price effects. In this post, we consider the implications of an alternative scenario where the U.S. dollar only appreciates part of the way. This could happen, for example, as a result of the uncertainty surrounding the policy response from other countries. As the proposed tax is effectively equivalent to an import tax combined with an export subsidy, it is possible that there could be retaliation from other countries in the form of taxes on U.S. exports or litigation with the World Trade Organization. If the U.S. dollar does not appreciate by the full amount of the tax, we argue that the effect of the tax will be to lower both U.S. imports and exports in the short to medium run.