The potential switch to destination-based taxation in the US has far-reaching implications for the US Dollar.
Under the current US taxation regime, goods and services are taxed
based on their origin, rather than where they are sold. Under a new
proposal being considered by House Republicans, taxes would be based
instead on where the goods and products are sold, with a so-called “border adjustment” that
would allow firms to deduct domestic wages. This would result in a
lower tax rate for firms that are net exporters and a higher tax rate
for net importers
give our initial take on the likely path for the Dollar should this
switch actually occur, which we think has about a 30 percent probability.
While models suggest the adjustment should be uniform across other
currencies, we expect the reaction would be quite different against EM
and G10 currencies given the various countervailing forces that would
come into play. Whatever the merits of the proposed legislation, we
think markets would treat it as an escalation of trade tensions between
the US and the rest of the world.
We therefore expect the largest net exporters – such as KRW and the RMB – to weaken substantially against the Dollar. This
would probably be compounded by concerns over supply chain disruptions
for firms, weighing on investor sentiment which could contribute to a
risk-off environment. For the G10, previous risk-off episodes
demonstrate that the market acts by rolling back expectations for Fed
hikes. In February of this year for example, the market went so far as
to price some probability of a rate cut.
the Dollar against the G10, the net effect is therefore more ambiguous,
but EUR and JPY should outperform EM, as in most risk-off periods.