Only a border-adjusted VAT solves---creates a level playing field for domestic producers

A border adjustment makes sense for a domestic consumption tax like a VAT since exports are not consumed domestically, but imported goods and services are. This makes the border adjustment a policy that levels the playing field so that all goods consumed in the US face the same tax rate regardless of where they are produced. Thus, it is quite different from a selective tariff.

All advanced countries except the US already have VATs (on top of corporate income taxes), and all of those VATs are border-adjusted. The border adjustment for VATs is explicit – taxes on production are rebated for exports; imports are taxed.

While explicit border adjustments may seem like a strange concept to Americans, implicit border adjustments are already present in state-level retail sales taxes. Goods produced in state A and exported to and sold in state B do not face state A’s sales tax. Goods produced in state B and imported to state A do face state A’s sales tax.

The border adjustment for a cash flow tax would also be implicit – the tax would exclude exports from tax and would not allow deductions for the cost of imported goods. By ignoring foreign transactions, the cash flow tax with border adjustment also removes the incentive for firms to relocate profits or move profitable activities outside of the country.

However, the border adjustment in the House Republican plan is probably not WTO-compatible. The WTO requires that imports and domestically produced goods be treated the same. But the DBCFT taxes the whole value of imports while only taxing the part of domestically produced goods that relates to above-normal returns to capital owners. This could be addressed by separating the DBCFT into a regular value-added tax and a wage subsidy elsewhere in the system.