Sunday, January 22, 2017

The Fall in the British Pound Models Border Adjustment Tax-Induced Inflation

Among the wishful thinking underlying the Border Adjustment Tax proposal is that importers' costs will fall so much from dollar appreciation that the massive new tax bills will essentially be funded by their suppliers' misfortunes.  Given that our factories are our lifeblood, the idea of shaking them down to pay a mega tax bill to Uncle Sam is quite unappealing.  

More importantly, the idea that we can somehow squeeze our costs enough to cover a Federal tax bill of 165% of earnings leaves me very skeptical.  We believe there is no way to cover this cost from our supply chain, ever, and that we will be forced to pass most or all of the new tax bill on to consumers.  That idea gives me the willies.  We haven't raised prices in two years.

This remarkable fantasy is set forth in the seminal article by Alan Auerbach and Douglas Holtz-Eakin, "The Role of Border Adjustments In International Taxation".  This article might as well have been handed down on a mountaintop chiseled into stone tablets for the amount of devotion it receives among advocates for Border Adjustment Taxes.  Pardon me for being an apostate.

The economists are flogging the idea that the dollar will skyrocket when their scheme becomes law.  According to them, it happens immediately and presumably endures forever. Have I lost you yet? Tuned me out because this is so obviously ridiculous? The economists posit that the dollar will appreciate by 25% based on a 20% tax rate.  There is a formula for this, don't worry, so it must be true.  Ahem . . . .

Anyhow, the notion that a rising dollar translates immediately (or ever) into lower costs for an importer is rather speculative, IMHO.  Most of us out here in the real world do not have a Forex department and do not play the futures market to make our money.  Remember, 99.7% of American businesses are small businesses.  We cannot capture currency fluctuations on the market, that's entirely fantastic and bad advice, too. It's important to note that we buy in U.S. dollars.  In fact, 85% of U.S. foreign liabilities are dollar-based.  In other words, it's not just us who do this.  

To capture currency gains, we will need to renegotiate each and every price on each and every item with each and every factory, and then that lower cost must both cover the (much) higher tax and flow to the bottom line. This is the same thing as saying that we must convince our factories to mark the product to market, no matter how their costs have changed (or not) and, importantly, bear the currency risk. This is never going to happen, based on my experience running this company for more than two decades.

Since a price negotiation is a zero-sum game, one way for a factory to play this is to say no. And if you can't develop a competitive second source, hardly an unprecedented situation, then what? I repeat, then what, Mr. Fancy Economist?

Our tax bills will not fluctuate with the currency, so we must pay a fixed sum to the government, with or without currency savings.  And if we can't save enough to pay Uncle?

That's why you can bet your bottom dollar that this plan is inflationary.  Very inflationary.

I can give you some evidence to chew on.  Consider the math of the Border Adjustment Tax - we must pay a premium of our new tax rate (25%) times the value of our imports as the BAT.  We are assessed this premium as a tax in this case. Notably, the same burden could be imposed on us by a depressed currency.  if the dollar fell by the same amount as (and in lieu of) the proposed tax, we would experience the same cost increase, right?  [I realize that the magic proposed by Auerbach and Holtz-Eakin runs the other way, but please bear with me.]  In other words, the burden on the company is the same - a 25% tax surcharge is the same money as a 25% cost increase caused by a falling home currency.

Turns out that post-Brexit, the British Pound fell from $1.50 on the evening of the Brexit vote on June 23, 2016 to a low last week of $1.20 - a 20% slide.  This simulates the two effects of Brexit - namely, U.S. exporters finding their products rising in cost over there, and British importers who buy in dollars experiencing a 20% rise in costs virtually overnight.

What do you suppose British importers are doing to fill the holes in their budgets?  Here are a few clippings for your information showing the rampant and shocking price increases being experienced over in the U.K.  [Inflation is also raging in Mexico, another country which experienced a massive fall in its currency.] You can find many more such stories if you spend a little quality time searching on Google. This is not my imagination . . . .

Marks & Spencer - raised prices 15%.  This came after a promise to hold prices.  "[An] unnamed supplier told The Times that the supermarket put itself in a 'ridiculously hopeless situation' by making the promise."

Unilever - raise prices by 10% on many food items and found itself in a war with Tesco's, one of their best grocery customers.  From the WSJ:  "But for importers, the fall of the pound is painful. Changes in exchange rates affect input prices almost immediately. The cost of imported materials for businesses rose by 9.3% in August compared with a year earlier. Such changes take time to filter through to consumers. Consumer prices increased less than 1% in the period. Still, for many U.K. residents, sterling’s fall is already causing discomfort. Overseas vacations are more expensive, keeping more Britons at home. Retail prices of many imported goods, such as electronics, wine and cars, have been ticking higher for weeks."  

Is it possible we've seen our last British tourist for awhile?  If Mr. Brady has his way, yes.

LEGO, Sainsbury's, Tesco, Brompton, Tesla, Ford Motors, GM Vauxhall, Nissan

Next (Retailer), Sainsbury's, Horby Toy Trains, RyanAir, Unilever, EDF, GB Energy

UK Inflation, British Airways, Apple (MacBooks), Holiday Inn, Morrisons, Nestle, Premier Foods, Christmas Pudding  The price rise in Christmas pudding is a good example of how inflation will flow downstream from imports.  Christmas pudding, which went up in price by 21%, is baked locally but contains sugar, among other things.  There are no sugar plantations in the U.K. Sugar is imported, so its price skyrocketed with the depreciation of the Pound.

Apple (apps), Dell, HP, Microsoft   Obviously, this will affect imported goods that are intangibles, too.  Apple raised prices by 25%, and Microsoft by 22%.

I am literally dumbstruck that our political leaders would risk setting this kind of fire. This is but one illustration of the extraordinary risks implicit in the Border Adjustment Tax.  On the specious justification that they are curing a "tax injustice" and the thin assertion that a revenue neutral plan will actually stimulate growth, House Republicans are taking massive historic risks.

Risks that affect YOU.  I hope you are starting to sweat.  You should be nervous.

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