FAQs About Border Adjustment

A border adjustment is a feature of a taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. system that modifies its treatment of trade. Specifically, it converts a tax system from a source-based system, which taxes what is produced in a jurisdiction, to a destination-based system, which taxes what is consumed in a jurisdiction.

Either system—taxing where value is created or taxing where it is consumed—is a neutral tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. that treats trade fairly.

Both kinds of tax can apply to the domestic market in the same manner. The difference is in the treatment of imports and exports. A source-based tax includes exports in its base, but not imports. A destination-based tax includes imports in its base, but not exports. Generally, consumption taxes, like sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding.  or value-added tax (VAT), are more likely to be destination-based, and income taxes are more likely to be source-based.

Some taxes, like a retail sales tax assessed by the final seller, are already naturally destination-based without much need for an explicit policy to make them so. What you buy at the store is subject to a sales tax regardless of where it’s from, while goods purchased in other states or foreign countries are exempt.

However, other taxes, such as a value-added tax with an invoice-credit system, might remit taxes at various stages of production in the domestic economy. If the final product turns out to be an export, a tax system needs to rebate the taxes paid thus far on that product to exempt exports. Any imports must be taxed at the border to bring them into the tax base. This pair of features in the value-added tax is a border adjustment that ensures it applies to domestic consumption.

Not at all. Over 170 countries operate a VAT, and VATs are universally border-adjusted: exports are zero-rated, and imports are taxed. The United States does not have a VAT, but it does have excise taxes that are border-adjusted, such as the gas taxA gas tax is commonly used to describe the variety of taxes levied on gasoline at both the federal and state levels, to provide funds for highway repair and maintenance, as well as for other government infrastructure projects. These taxes are levied in a few ways, including per-gallon excise taxes, excise taxes imposed on wholesalers, and general sales taxes that apply to the purchase of gasoline. and cigarette excise taxAn excise tax is a tax imposed on a specific good or activity. Excise taxes are commonly levied on cigarettes, alcoholic beverages, soda, gasoline, insurance premiums, amusement activities, and betting, and typically make up a relatively small and volatile portion of state and local and, to a lesser extent, federal tax collections..

What would be novel is applying a border adjustment to a corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. or cash-flow tax, which raises a distinct set of theoretical and practical questions that do not arise with a conventional VAT. The idea to border-adjust the corporate income tax first received significant political support in the US in the lead-up to the 2017 Tax Cuts and Jobs Act, but was not ultimately adopted.

A textbook version of a border adjustment has no net impact in the long run. In the very long run, trade between the United States and rest of the world must balance in present discounted value. As a result, imports must equal the present value of all future exports and vice versa. This is because trade represents net borrowing and lending between the US and the rest of the world. What we borrow (import) we have to pay back (export). Economic literature dating to Abba Lerner in 1936 has posited a long-run neutrality between taxing imports and taxing exports, which implies that shifting a system from one treatment to the other would have no impact.

Under a simple long-run model, border adjustments are accounted for in foreign exchange rates, offsetting the tax on imports and the subsidy on exports simultaneously, and leaving the relative prices of imports, exports, and domestic goods all unchanged.

However, in more complex models of the economy, border adjustments can have real economic effects; economists have noted exceptions to the theoretical result, some of which are significant to the US.

There are reasons to believe the dollar would appreciate only partially relative to the theoretical result, especially if the border adjustment fails to capture certain industries or activities in its net. Additionally, a number of transition dynamics—that is, temporary but nonetheless substantial economic effects—would exist if the US were to adopt a border adjustment quickly and unexpectedly. Therefore, the long-run and theoretical impact has significant exceptions.

If the US were to change its tax system for trade, that would also change the supply and demand for currencies. Suppose the US applies a border adjustment. By exempting exports, the adjustment initially increases foreign demand for US goods and the dollars needed to pay for them. Meanwhile, by taxing imports, the adjustment reduces US demand for foreign goods and the foreign currency used to pay for them. Both effects increase the value of the dollar on currency markets. If both effects are complete, this approaches the theoretical result and leaves real trade prices and consumer prices roughly unchanged.

Yet, if one or both of these effects are incomplete—for example, because some industries or activities escape the import taxation or fail to claim the export subsidy—then the dollar will not appreciate as much as predicted.

In the textbook model with complete appreciation, no. The dollar appreciation would fully offset both the new tax on importers and the new subsidy for exporters, leaving both in roughly the same position as before. This is the sense in which a border adjustment is said to be "trade neutral." In practice, the answer depends on whether the currency adjustment is complete.

If the dollar does not fully appreciate, the border adjustment would increase prices of imports for those importers who do pay tax; the benefit of the appreciating currency would be insufficient to offset the tax. Meanwhile, the partial appreciation of the dollar would still reduce, through foreign exchange effects, the prices of imports that fall outside the net.

Similarly, an incomplete appreciation of the dollar would increase the competitiveness of exporters capable of claiming the export rebate; the benefit of the export rebate would exceed the drawbacks of an appreciating currency. However, the partial appreciation of the dollar would reduce the competitiveness of exporters unable to claim the rebate but nonetheless subject to an appreciation of the currency.

No, a tariffTariffs are taxes imposed by one country on goods imported from another country. Tariffs are trade barriers that raise prices, reduce available quantities of goods and services for US businesses and consumers, and create an economic burden on foreign exporters. is a standalone tax on imported goods. A border adjustment is a structural feature of a broader tax system that simultaneously exempts exports and taxes imports from a tax base. In theory, a properly functioning border adjustment is a trade-neutral swap between two trade-neutral tax systems.

However, as noted, if currency appreciation is incomplete, a border adjustment can have tariff-like effects on imports subject to it.

Some advocates of border adjustment have promoted it precisely for its potential protectionist effects—as an alternative mechanism to tariffs for taxing imports. This framing is in tension with the theoretical case for border adjustment, which rests on the premise that the policy does not affect trade flows.

In the standard model, no. Because the border adjustment is expected to be offset by currency movements, it should not change the volume of imports or exports. Trade deficits are driven by macroeconomic factors—primarily the gap between national saving and investment—that a border adjustment does not directly address.

In a less simple real-life model with incomplete currency appreciation, the effect of a border adjustment on US trade activity is uncertain, with competing effects in both directions. A prominent scholar of border-adjusted taxation, Alan Auerbach, notes that border adjustment may reduce the measured trade deficit by reducing the returns to transfer mispricing.

Inside the 10-year budget window Congress often uses to evaluate budgetary impacts, the United States is likely to run a trade deficit, as it has done persistently for many decades. The value of its imports exceeds the value of its exports. Therefore, a destination-based tax base (imports included, exports excluded) is therefore mechanically larger than an origin-based base (domestic production). At any given tax rate, the wider base raises more revenue. Inside a 10-year budget window, this can look like a very large revenue gain.

In the long run, however, there’s no guarantee border adjustment raises revenue in a given year or into the future. In a country with a trade surplus, border adjustment loses net revenue.

The US presently runs trade deficits, largely because it is an attractive place to invest, and foreigners provide net goods and services in exchange for US financial assets. But it may run trade surpluses in the future; the US is in a negative net international investment position. If future investment opportunities lie outside the US more, then the US will run trade surpluses and actually lose revenue from border-adjusting a tax.

Even if trade flows are unchanged, a border adjustment can create large transitional wealth effects through currency and asset revaluations.

An appreciating dollar would mean that foreigners holding US-based assets would see the value of those assets increase in their home currency. Simultaneously, US individuals and businesses holding foreign assets would see those assets decline in US dollar value. These effects are genuine tax incidenceTax incidence is a measure of who bears the legal or economic burden of a tax. Legal incidence identifies who is responsible for paying a tax while economic incidence identifies who bears the cost of tax—in the form of higher prices for consumers, lower wages for workers, or lower returns for shareholders. that applies even in a perfect theoretical border adjustment, but they only happen in transition. Going forward, there would be no future revaluation unless tax policy were changed again.

Importantly, however, a border adjustment would not burden households the same way as tariffs. These transition effects would only fall on owners of capital.

In the case of an incomplete border adjustment, exporters unable to claim full export rebating or importers would bear the economic incidence.

Potentially—and this is one of the strongest arguments in its favor. Under the current source-based system, multinational firms have strong incentives to use transfer pricing, intellectual property placement, and other strategies to shift reported profits to low-tax jurisdictions. A destination-based system largely eliminates these incentives, because the tax base is determined by where sales occur—something much harder to manipulate than where income is booked. But destination-based taxation does not eliminate tax planning; it merely reduces tax planning opportunities relative to source-based taxation.

A reduction in profit shiftingProfit shifting is when multinational companies reduce their tax burden by moving the location of their profits from high-tax countries to low-tax jurisdictions and tax havens. would mean that a border adjustment would reduce the measured trade deficit. Firms would no longer overprice imports and underprice exports, reducing the measured gap between them.

Not all imports and exports are cleanly defined. Certain domestic industries effectively function as exporters by selling to foreigners who are physically in the United States. Tourism, hospitality, higher education, and real estate are prominent examples. A stronger dollar would make these sectors more expensive for foreign buyers, but unlike conventional exporters, they may not receive a corresponding tax rebate under a border adjustment.

Some imports that might owe tax in theory could be untaxable in practice—for example, online payments to small internet-based producers in other countries are imports, but the IRS might struggle to compel anyone to remit tax.

If a border adjustment were applied to a business income tax code with a narrower base than a traditional VAT, but exporters were not able to claim negative tax burden, a border adjustment regime for business income taxes would remain incomplete.

Border adjustment can significantly simplify some parts of cross-border business taxation—especially the rules governing controlled foreign corporations, transfer pricing, interest allocation, and foreign tax credits. But simplification is not guaranteed. Defining "destination" is straightforward for physical goods but harder for services, digital commerce, and hybrid transactions. And refundability and loss treatment for net exporters can be administratively and politically difficult.

Furthermore, a substantial share of US business activity occurs through pass-through entities (S corporations, partnerships, sole proprietorships) that are not subject to the corporate income tax. If the border adjustment only applies to C corporations, imports could be routed through pass-through entities to avoid the tax, undermining the uniformity that a border adjustment would require to be fully neutral. A border adjustment of the corporate income tax code would likely require a border adjustment of the business components of the individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source code as well.

If the goal is a destination-based system that is economically coherent and administrable, several design choices become critical:

• Symmetry and uniformity. Carveouts and exemptions undermine the exchange-rate adjustment mechanism and create real sectoral distortions. Every exception makes the system look more like a selective tariff and less like a neutral tax-base shift.
• If net exporters cannot receive timely cash refunds for excess credits, the system creates cash-flow harm to exporters and weakens the theoretical neutrality channel. This is politically challenging but economically necessary for a complete border adjustment.
• Defining destination for services and digital trade. Even for destination-based taxation, which is overall easier and more robust to profit-shifting concerns than source-based taxation, the digital economy presents some challenges in determining apportionment of income and compelling tax to be remitted.
• Transition rules. Anticipatory currency movements, contractual rigidities, and the lag between announcement and implementation might have substantial economic impacts worth considering even in a tax that is otherwise well-designed over the long run.