Effects of Consumption Taxes on Real Exchange Rates and Trade Balances

29 Pages Posted: 5 Apr 2017

See all articles by Caroline Freund

Caroline Freund

Peter G. Peterson Institute for International Economics

Joseph Gagnon

Peterson Institute

Date Written: April 4, 2017

Abstract

This paper examines the effects of border-adjusted consumption taxes (mainly value added taxes or VATs) in a sample of 34 advanced economies from 1970 through 2015. We find that the real exchange rate tends to rise by the full amount of any consumption tax increase, with little effect on the current account balance and modest offsetting effects on the trade and income balances. Case studies suggest that adjustment comes initially through prices. We note that the border-adjusted cash flow tax of the House Republicans differs in important ways from consumption taxes used in our study, which raises the possibility of a slower adjustment process with temporarily larger trade effects.

Keywords: VAT, border tax adjustment, exchange rate adjustment, current account adjustment

JEL Classification: F31, F32, H20

Suggested Citation

Freund, Caroline and Gagnon, Joseph, Effects of Consumption Taxes on Real Exchange Rates and Trade Balances (April 4, 2017). Peterson Institute for International Economics Working Paper No. 17-5. Available at SSRN: https://ssrn.com/abstract=2946204 or http://dx.doi.org/10.2139/ssrn.2946204

Caroline Freund (Contact Author)

Peter G. Peterson Institute for International Economics ( email )

1750 Massachusetts Avenue, NW
Washington, DC 20036
United States

Joseph Gagnon

Peterson Institute ( email )

1750 Massachusetts Avenue, NW
Washington, DC 20036
United States

HOME PAGE: http://www.piie.com

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