However, a BAT would discriminate against imports and so would likely eventually be ruled as being in violation of WTO rules. In the meantime, our trading partners could reasonably decide that a tariff by any other name stinks as sour and impose retaliatory tariffs on us.
There is actually, a solid argument for eliminating our corporate income tax altogether and replacing it with a VAT. The U.S. has relatively high income taxes (including the corporate income tax) and relatively low consumption taxes. Compared to almost all of our trading partners, our tax system favors consumption over production. One natural result of this is that, as a nation, we tend to overconsume and underproduce, resulting in a trade deficit. However, it hardly seems reasonable to demand that the rest of the world adopt our system or face tariffs. It seems more sensible to just change ours.
So what’s likely to happen? The politics are tangled to say the least. However, the President would likely have a harder time getting Congress to approve of broad tariffs than a more opaque corporate tax reform that achieves the same result. For his part, the House Speaker will want to achieve a victory on his pet project. Congress will run into opposition from retailers, oil refiners and other industries that will argue that this amounts to a major tax increase on them which they will have to pass on to consumers. Nor are they likely to be assuaged by the very dubious claim that the dollar will immediately appreciate enough in response to such a tax as to negate its effects on import prices.
However, the way out of this dilemma for both the Congress and the President is simply to abandon all pretense of revenue neutrality and cut the rate to a low enough level as to make the pain reasonable, particularly in return for an abolition of the corporate income tax.
In summary, while the political chess match will be complicated, a replacement of the corporate income tax with a low-rate cash-flow tax with border adjustments seems the most likely outcome. If this occurs, it could boost after-tax operating earnings and the budget deficit. However, it would also add to inflation, potentially increasing interest rates. It would finally, likely increase the value of the dollar. In combination, these changes would favor U.S. stocks over bonds and U.S. stocks over international and particularly EM stocks.
Something to consider at the start of just the second full week of the Trump Presidency.
David Kelly is chief global strategist at JPMorgan Funds.