We examine the effects of a proposed border adjustment tax (also referred to as the “BAT”) on the shareholder wealth of publicly traded firms. Border adjustment has emerged as a controversial feature of proposed U.S. corporate tax reform, as it would be a dramatic departure from longstanding corporate tax policy (Avi-Yonah and Clausing 2017; Auerbach and Devereux 2017; Feldstein 2017; Rubin 2017). With a border adjustment tax, export revenue would be exempt from tax, while the domestic costs to produce the revenue would continue to be tax deductible. The cost of imported goods and services, however, would no longer be deductible for tax purposes. According to some proponents, a border adjustment tax is a way of encouraging exports and discouraging imports.
Conversely, many leading academics argue there are economic reasons to believe that exchange rates would adjust to offset any tax reduction to exporters and the additional taxes on importers (Auerbach et al. 2017). Belief in this prediction, however, is not universal, even among academics, and depends on several assumptions that may not hold in practice (Graetz 2017; Summers 2017). Many economists in the private sector appear to take a middle ground, predicting less than full exchange rate adjustment, such that border adjustment would result in winners and losers among corporations (Amiti et al. 2017).
There is a notable absence of empirical evidence about the economic effects of a border adjustment tax. Moreover, what little empirical evidence does exist on border adjustment is limited to Value Added Tax (VAT) systems, within which border adjustment is commonplace (Desai and Hines 2005). As others have pointed out, border adjustment has never been adopted in a corporate income tax system (Weisbach 2017). Given the dearth of evidence on the topic, academics and policy makers assessing the effects of a border adjustment tax are left with only abstract theoretical discussions (reasoned they may be) to guide them. Our objective is to provide initial empirical evidence on one aspect of the possible economic effects of a border adjustment tax on shareholder value. While a full analysis of the effects of a border adjustment tax would require it to be enacted and time to pass, we can examine equity values, which are forward-looking, to provide early evidence of its effects on shareholder wealth.
To examine the shareholder wealth effects of the border adjustment tax, we examine share price movements of public firms on days of heightened attention to the proposed border adjustment tax. The underlying assumption, standard in event studies, is that investors in the market take what is known about the plan and how it would affect future cash flows of public firms and trade accordingly (Kothari and Warner 2008).
To examine the market reaction to the proposed border adjustment tax, we need to identify the days in which the issue became more salient to the market and classify the news as being either favorable or unfavorable towards the likelihood of enactment of the border adjustment tax. We use Google Trends, a publicly available tool to measure the relative frequency of the volume of search traffic for a given search term, which allows us to identify days with substantial public attention paid to the border adjustment tax.
There are nine days where search interest as measured using Google Trends related to the border adjustment tax noticeably spikes. We find evidence of significant changes in equity values on the dates of search volume spikes. Specifically, we examine cross-sectional differences in the returns of import-intensive and export-intensive firms. We find that on days of high search interest in border adjusted taxes indicating an increasing probability of adoption, import-intensive firms, such as retailers, experience significant negative abnormal returns. It would be difficult for other aspects of proposed tax reform, such as tax rate reductions, to explain these cross-sectional results.
Our findings, suggesting that a border adjustment tax does affect equity values, have several implications. First, our results imply that border adjustment, at least as assessed by equity market investors, would not be neutral to individual firms. Connecting back to the economic theory behind neutrality of a border adjustment tax, this finding is consistent with the market believing exchange rates would not adjust enough to offset the increased tax costs to import-intensive firms. Second, the equity market reaction suggests that investors anticipate at least a portion of the economic incidence of a border adjustment tax would be borne by shareholders of the firms. Third, our evidence is, in some regards, inconsistent with predictions of substantial exchange rate effects. Some researchers predict that border adjustment taxation would cause the U.S. dollar to appreciate, which would reduce the value of U.S. companies’ foreign currency denominated assets and earnings. However, we find little reaction to border adjustment taxation for multinationals, which are most likely to have foreign denominated assets and earnings.
Our evidence is by nature limited and subject to caveats. The border adjustment tax has been proposed but may not become law. Because the law has not passed nor time been allowed for new product-market equilibria to form, no one can know for sure what the economic consequences of the border adjustment tax would be. However, regardless of such limitations, we believe our empirical evidence of the equity market response provides useful information to a debate that has been relatively void of such evidence.