Border Adjustment Tax: A Primer

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By Laura Davison

A central feature of House Republicans’ tax plan, which would tax U.S. imports but not exports, has suddenly become one of the most contentious issues in the tax code overhaul debate, pitting companies that sell overseas against those that buy foreign products.

Border adjustments serve as a way to alter consumption taxes, like the value-added taxes many European countries impose on each stage of production, as products are sold internationally. The adjustments strip products of taxes when they are exported, and importing countries add their taxes as products are brought onshore.

Proponents say it isn’t trade policy and it doesn’t favor exports over imports. It “levels the playing field” so that American products can compete overseas, and goods purchased domestically are all subject to the same taxes, Douglas Holtz-Eakin, the president of the American Action Forum, said.

But powerful interests, including Koch Industries Inc. and large retailers like Wal-Mart Stores Inc. and Best Buy Co. Inc., will fight the move throughout the process, arguing that it would raise prices on products that aren’t economically feasible to make in America.

What Are the Revenue Projections?

The plan doesn’t yet include many specifics, such as the size of the adjustment, though analysts are figuring on rates around 20 percent. Instead of an import official at the border imposing taxes or writing an exemption check, the House proposal would have taxpayers ignore all export transactions when they are calculating their income. Importers would be denied a deduction for the cost of the products they import.

Border adjustments serve another important purpose for the GOP tax plan. The U.S. trade imbalance means that the import taxes would raise more than $1 trillion over 10 years, according to many estimates based on a decade-old tax overhaul report for former President George W. Bush. At the time the report was written, it estimated import taxes would raise $775 billion over 10 years. Current estimates use more recent trading data to reach figures that top $1 trillion.

This $1 trillion would be used to pay for lower tax rates for businesses and individuals. The corporate rate in the plan is 20 percent, down from the current 35 percent. Individual rates top out at 33 percent, reduced from the current 39.6 percent. The plan also would provide an immediate deduction for businesses on the costs of capital investment, a provision commonly referred to as full expensing.

Retailers, mobile phone producers and oil refiners that rely on imports aren’t enthused by the idea of paying an import tax for the products they sell. But large exporters, such as General Electric Co., Boeing Co. and Honeywell International Inc., would generate large net operating losses from the products they send overseas, effectively reducing their tax liability to zero.

Who Are Winners and Losers?

So far, winners under the border adjustability plan have been less vocal than opponents, who fear the plan could cause the price of imports, such as clothing and crude oil, to rise 20 percent, a cost that would likely get passed on to consumers. A group of large exporters, including Dow Chemical Co., is planning to launch a group to support the plan.

Exporters are working to compile a coalition supporting border adjustability, but have to tread lightly in their messaging so the provision doesn’t appear to be a large tax break for multinationals, a tax lobbyist said.

But some economists, including Holtz-Eakin, say both those fears are unfounded, because both importers and exporters will come out on economic equal footing, as currencies adjust to compensate for the amount of the tax.

The demand for dollars to buy U.S. products would increase if the cost of the products is relatively lower because of the border adjustment. At the same time, the supply of dollars internationally would decrease because domestic companies would be importing less, according to the right-leaning Tax Foundation. Those two forces work in concert to increase the value of the dollar to compensate for the amount of the tax.

“The border adjustment does not have trade effects,” according to a Treasury Department report on the tax plan. “Instead, we’ve seen that the real exchange rates move—after-tax domestic prices rise relative to foreign prices by the amount of the tax.”

However, economists at investment banks, including Goldman Sachs & Co., have been more skeptical that currency values would move as much or as quickly as some academics have said. If the dollar didn’t move significantly it would lead to a relative downside for importers, with exporters coming out as winners.

“This debate will not be resolved. People are convinced of one view or another,” Gary Clyde Hufbauer, Reginald Jones Senior Fellow at the Peterson Institute for International Economics, said. “If they implement this, a year from now, economists are going to do a retrospective and they won’t agree on the reason why currencies did or didn’t shift.”

Is It a Tariff?

The import tax and the export subsidy have to be equal, said Alan Viard, a resident scholar at the conservative American Enterprise Institute, who has studied border adjustments. A 15 percent exemption for exports and a 20 percent tax on imports would be the same as a 15 percent border adjustment and a 5 percent tariff, he said.

“That would come with all the harmful trade barriers if you were to adopt it in isolation,” Viard said.

Trump has been skeptical about border adjustments. He supports the idea of a “border tax” for companies that send operations overseas, as well as a tax on imports from countries where the U.S. runs a trade deficit, but has expressed wariness of the complexity of the plan.

House Republicans have been working to persuade him in recent weeks that their plan will achieve many of the same results he’s seeking in a tax on companies that move offshore. Trump has signaled a willingness to use some of the revenue generated from an import tax to fund building a wall on the U.S.’s border with Mexico.

Many who have analyzed the plan, including those who generally support the idea, aren’t clear if it will comply with World Trade Organization rules.

WTO regulations allow border adjustments on “indirect taxes,” which includes sales, excise and value-added taxes, and all taxes other than direct taxes, such as an income tax. The House GOP tax plan moves away from direct corporate income taxes and toward a consumption tax, but it isn’t a pure VAT either.

What About World Trade Organization Concerns?

To become more VAT-like, the plan could eliminate the deduction for wages and the payroll tax. However, that idea is unpopular with Republicans who have avoided using the “v” word during the rollout of the plan.

Brady has said he is confident the plan would be upheld if other countries tried to challenge it in the WTO. The U.S. could also negotiate with the organization on altering WTO regulations to allow the hybrid plan, which has come to be known as a destination-based cash flow tax.

“It’s not a choice of the House plan with border adjustment or without. It’s a choice of the House plan with the border adjustment or the plan with some other way to protect the tax base,” Holtz-Eakin said. “You don’t have the luxury of saying I want the plan, just without the border adjustment. Then the whole thing falls apart. You have to have something else.”

To contact the reporter on this story: Laura Davison in Washington at lDavison@bna.com

To contact the editor responsible for this story: Meg Shreve at mshreve@bna.com

For More Information

The Treasury study, “What Would a Cash Flow Tax Look Like For U.S. Companies? Lessons from a Historical Panel,” is at https://www.treasury.gov/resource-center/tax-policy/tax-analysis/Documents/WP-116.pdf.

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