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Effects of Consumption Taxes on Real Exchange Rates and Trade Balances

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.