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Prof. Martin Feldstein Makes a Poor Case For the Border Fax
Raymond Richman, 2/28/2017

Martin Feldstein, professor of economics at Harvard, former chairman of the Council of  Economic Advisors, and a recognized tax expert, writes in an opinion piece in the Wall Street Journal, 2/27/2017, that the border-adjustment tax proposed by some House Republicans “would not hurt American consumers and businesses,” nor affect the overall trade deficit. He gave the following reason for his astonishing conclusion:

Retailers and importers understandably fear that the tax would raise the cost of their products, ultimately increasing the prices to consumers. But the border tax would also cause the international value of the dollar to rise, reducing the cost of imports by enough to offset the tax.

Here’s why the dollar would rise: Without a change in the currency’s value, the border adjustment would cause imports to fall and exports to rise, reducing the overall trade deficit. But it is a fundamental fact of economics that the size of a country’s trade deficit equals the difference between national investment and national savings. Since the border adjustment tax would not alter either investment or saving, there must be no change in the trade deficit

Economic theory does not support Feldstein’s analysis. A country’s investment and savings are affected by trade deficits and surpluses but private investment and savings depend on rates on rates of return and rates on borrowed capital and government investment depends on Congressional and administration decisions while savings depends on the amount of income after tax of individuals and corporations. The author’s conclusion confuses an accounting identity with a statement of causes and effects.

Gross Domestic Product is such an identity: GDP = C + I + G + (X – M), i.e. gross national product is the sum of Consumption, Private Investment, Government consumption and investment, and Exports minus imports, the foreign trade balance. While changes in its components, called variables, will affect the GDP and other components, they cannot be said to cause or determine the changes observed in the other variables. The following identity can be derived from this identity; (S(P) + S(G) - I = (X – M) i.e., private savings and government savings minus investment equals the trade balance. This identity-- it is still an identity—lies at the basis of the professor’s analysis. They are identical but they are basically independent of the others. Savings and investment could just as easily be said to determined by net exports. But the components of the identity are basically independent of one another.

What is more egregious of Feldstein’s defense of the border tax is that 1) we already have sales taxes at the State level which are border taxes. So the proposed rate of 20% is more like 27% or so, 2) giving the federal government another tax is undesirable, 3) the burden of the border tax falls entirely on the middle class, and widening the inequality of wealth, 4) it falls with equal weight on countries with which we have trade surpluses and those with which we have huge chronic trade deficits, 5) the border tax violates international law..

The best way in our opinion to balance trade is to impose the single-country-variable-tariff as we indicated recently on this blog. We believe it can be imposed under international law. It is not a protective tariff; it is a remedial tariff and is reduced as trade with a particular country is balanced.