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Discount retailers like Dollar Tree Inc. and Five Below Inc. that rely on inexpensive, imported products would likely be among the hardest hit if House Republicans are able to impose a border-adjusted tax as part of broader tax reforms.
Aside from the apparel industry, “when you look at the list of retailers and the different subgroups, my view is that the discount dollar stores—the ones with the higher discretionary mix such as a Dollar Tree or a Five Below—would be impacted the most,” Bloomberg Intelligence senior U.S. retail analyst Poonam Goyal said. Border adjustment could “substantially displace their current business model,” she said.
The border adjustability provision, which would exempt exports but levy a 20 percent tax on imports, is a cornerstone of the House GOP tax plan. The idea has garnered many opponents, including retail groups and the Koch brothers’ Americans for Prosperity. Its political viability could be called into question, especially because the White House has waffled on the issue and Sen. Charles E. Grassley (R-Iowa) has said the idea won’t be included in any legislation the Senate Finance Committee puts out.
Both Dollar Tree and Five Below maintain strict price points. As their names suggest, everything sold at Dollar Tree is priced $1 or less and everything at Five Below is $5 or less.
If Dollar Tree’s imports are taxed at 20 percent as proposed in the GOP plan, “they may no longer be able to sell those goods for a dollar to maintain their margin or to even preserve their margin and be profitable,” Goyal said. The same can be said for Five Below and its $5 limit, she said.
Five Below expressed its concerns with the GOP’s border adjustment plan in its annual earnings report for the fiscal year ended Jan. 28. “Tax proposals may include changes, which could, if implemented, have an adverse impact on us, including a ‘border adjustment tax’ or new import tariffs, which could adversely affect us because we sell products that are principally manufactured outside the United States,” the company said.
Discount retailers rely on imports from countries like China that manufacture inexpensive products, which can be sold at low prices, Goyal said. This is especially important for a company like Five Below that sells a lot of discretionary goods, meaning nonessential but desirable products, she said. “We don’t make any of that stuff here” in the U.S., she said.
According to filings with the Securities and Exchange Commission, Dollar Tree buys 41 percent to 43 percent of its merchandise from foreign vendors. Five Below imports about 33 percent of its inventory.
And those are just the direct imports, said David French, senior vice president for government relations at the National Retail Federation. Most likely, many of the domestic vendors those companies use also purchase goods abroad, he said. “I imagine that they are indirectly importing from vendors in the United States who have a large amount of imports in their supply chains,” French said.
Companies like Dollar Tree and Five Below would only lose the deduction on the cost of direct imports, but their vendors would also lose the deduction on imported goods, “so it’s going to mean higher costs across the board,” he said.
If a border-adjusted tax is enacted, discount retailers have two options, Goyal said.
“They can adjust the types of products that they sell,” she said. For example, now at Five Below “you could probably get a whole big beach set with the shovels and everything else that comes for kids, and it would be a big basket of 15 or 20 things,” Goyal said. “If there was an import tax, maybe they can’t sell that anymore.” Retailers also can adjust package sizes. Companies may decide to sell pencils in packs of five or two instead of 10, she said.
The other option is for discount retailers to say: “It’s no longer a one-dollar store; it’s a two-dollar store. It’s no longer Five Below; it’s Ten Below,” Goyal said. “That’s just something they’ll have to think about: What makes the most sense?”
In a March 1 quarterly earnings call, Dollar Tree CEO Bob Sasser said the company can’t know the exact impact of a border adjustment tax until Congress passes legislation. But “we, like most other retailers, feel that the border tax would result in a significant burden to the consumer, both through reduced choices and higher prices,” he said.
“We’re working with the National Retail Federation, Retail Industry Leaders Association and the Americans for Affordable Products group to express our concerns,” Sasser said. Trade groups have been pushing for industry-specific carveouts under the border adjustment plan, but the House Ways and Means Committee isn’t budging. Instead, the committee is working on transition rules that would help ease companies into the new system.
Sasser pointed out that Dollar Tree has a proven history of adapting its business model to maintain its dollar price point. “Over the past 30 years, we have seen inflation in all costs including product, labor, transportation and real estate,” he said. “And we’ve been able to successfully maintain our $1 price point, deliver relatively consistent gross margins and still provide tremendous values to our shoppers.”
Dollar Tree declined to comment beyond what was said on the March earnings call.
Goyal pointed out that Dollar Tree may actually be more insulated from the border adjustment plan’s impact because of its recent acquisition of former competitor Family Dollar Stores Inc.
“Family Dollar is essentially a small grocery store—75 percent of their sales are from consumables.” Aside from food products, consumable merchandise includes tobacco, health and beauty aids, household chemicals, paper products, hardware and automotive supplies, diapers, batteries, and pet food and supplies, according to company filings.
Companies that sell a lot of food products may be more protected from the effects of the GOP’s border adjustment plan because most food items can be sourced domestically, Goyal said.
So while the Dollar Tree namesake store would absolutely be impacted by the import tax, the company as a whole—including the Family Dollar stores—may be somewhat protected, she said.
The concerns being raised by retailers and industry associations are overblown, said Gordon Gray, director of fiscal policy at the American Action Forum.
Gray, who formerly worked for Republican Sens. Rob Portman (Ohio) and John McCain (Ariz.), said the border adjustment plan in isolation “will lead to a dollar appreciation that will offset any of the tax burden that import dependent industries should see.”
Those companies “would not be the bearer of the tax, nor would their consumers, because their purchasing power would increase relative to where it is now,” Gray said. And “their after-tax profits would remain unaffected.”
Kyle Pomerleau, director of federal projects at the conservative-leaning Tax Foundation, backed up the currency adjustment theory in a December 2016 report. “Standard economic theory states that a border adjustment ends up in a wash for both exporters and importers because prices adjust to leave the trade balance unchanged,” he said. “Specifically, the value of the domestic currency adjusts upward.”
One reason this adjustment would occur is that an import tax would raise the cost of imports and reduce domestic demand for them, leaving foreigners with fewer U.S. dollars and pushing the value of the dollar up relative to other currencies, he said.
Not everyone agrees with the currency adjustment theory. Reuven S. Avi-Yonah, director of the International Tax LLM Program at the University of Michigan Law School, previously told Bloomberg BNA he didn’t see much evidence that would suggest foreign currency markets would react significantly to the border adjustment plan, especially since several countries like China and Japan don’t let their currencies trade freely against the U.S. dollar.
Aside from the currency argument, Gray said companies need to consider how much they stand to gain from other provisions in the GOP’s tax plan.
Retailers, which currently have a high relative effective tax rate, would benefit tremendously from the lower 20 percent corporate tax rate, he said.
A Five Below executive echoed this sentiment in a March 22 quarterly earnings call. “With regards to the border tax, we would expect that that will be part of some broader tax reform,” said Kenneth R. Bull, the company’s chief financial officer. And “there could be other benefits to be able to offset that,” he said.
“It’s difficult to speculate at this time,” Bull said. “So we’re obviously staying on top of the situation and then we’ll react accordingly when we get some more clarity.”
Five Below didn’t immediately respond to requests for additional comment.
With assistance from Laura Davison in Washington.
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