Fitch Ratings says in a new report that the proposed introduction of a border adjustment tax (BAT) to the US corporate tax system could have sizeable adverse spillovers to other countries if implemented.
According to Fitch: It could raise the burden of US dollar-denominated debt in emerging markets (EMs), precipitate strains on US dollar-linked exchange rate regimes, worsen current account balances and GDP growth for major exporters to the US, reduce FDI inflows, and lead to a loss of tax revenues for countries that host US multinationals.
House Republicans’ “Better Way” tax reform proposals, which are a focal point for plans to reform US taxation, would shake up the global tax system, with major implications not just for the US, but also for the rest of the world. However, it is unclear whether these proposals will pass into law, as they face opposition in the Senate, and the White House has so far been largely non-committal.
Fitch believes the US dollar would appreciate markedly if the reform proposals become law, albeit not by the 25% predicted by economic theory to fully offset the impact of the proposed 20% BAT on the US trade balance. The path of the US dollar would be a key factor in transmitting spill-overs to the rest of the world. Real exchange rate adjustments could be a slow process, with lasting effects on trade and growth.
An appreciation of the US dollar would lead to a rise in debt/GDP ratios and debt service burdens of EMs with US dollar-denominated debt on their balance sheets. Fitch estimates that Argentina, Turkey, Brazil and Indonesia have the highest sovereign and corporate sector US dollar-denominated debt (as a percent of GDP) among large EMs. Countries with dollarised banking systems could see an increase in non-performing loans.
Sharp US dollar appreciation could present sovereigns with some form of fixed regimes against the US dollar with an unpalatable policy choice of either devaluing nominal exchange rates against the US dollar or tolerating higher trade-weighted exchange rates with adverse implications for exports and growth. China’s policy response could have repercussions and spill-overs to third countries.
Foreign exporters would lose cost competitiveness in the US unless the US dollar fully appreciated to offset the impact of the BAT on import costs. This would likely mean a fall in rest of the world (ROW) exports, slower GDP growth and some deterioration in current account balances. The US is the largest export market for 22 Fitch-rated sovereigns, with Mexico (81% of merchandise exports) and Canada (77%) the most exposed.
The BAT would lead to a loss in ROW corporate tax revenues, owing to lower company profits from exports to the US, a reduction in US profit-shifting incentives and some relocation of companies to the US. The BAT is designed to raise around USD1 trillion over 10 years, some of which would be at the expense of other countries. Luxembourg, Ireland, Netherlands and Singapore in particular could see outflows of FDI and US operations, with potential adverse implications for public finances and GDP.
The ROW would gain from the revaluation of external assets in the US or those otherwise denominated in US dollars (including 63% of global foreign exchange reserves), which could improve their net external debt and net international investment positions.
• Link to the original report
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