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Deconstructing the Border Adjustment Tax

August 10, 2017

Border Adjustment – politicians on both sides of the aisle have lobbied the term back and forth, representing it both as a cure to America’s broken tax code and as an “idea so stupid that only an intellectual would believe [it].” [1] With House Republicans promising a comprehensive tax reform package by 2018, it is important to understand the fundamentals of the proposal.

The Border Adjustment Tax, in short, is a tax on imports. Currently, the US tax system is structured such that exports are taxed, whereas imports are tax-deductible. Companies are able to reduce their overall tax burdens by deducting the cost of imports from their revenues. [2] The BAT would upend the existing tax system so that exports, rather than imports, are given tax-preferential status. The BAT is seen as a way to combat the incentive of corporations to offshore profits (i.e. corporate inversion), as well as a way to encourage domestic manufacturing and exports.

The Border Adjustment Tax currently is presented as an alternative to the Trump administration’s proposal of a border tariff. As any scholar of U.S. history will emphasize, tariffs have an inherent risk of a “trade war” with other countries. The BAT is meant to achieve the same outcome as a tariff, but without the potential reprisal from other countries. The legality of the BAT is questionable, however. The World Trade Organization, the organization that regulates international trade, has said that the Border Adjustment Tax could violate international trade rules, which prohibit direct export subsidies.

The idea of the tax initially was proposed in two papers by Berkeley economist Alan J. Auerbach in 1997 and in 2010. [3] His idea has since been rapidly adopted in policy circles, with House Republicans including it in their “A Better Way” tax reform proposal of 2016. Paul Ryan, the Speaker of the House, has proposed to address the issue of corporate inversion with a 20% Border Adjustment Tax rate that concurrently makes U.S. exports tax-deductible.

Image: U.S. corporate effective tax rates fell from 29% in 2000 to 17% in 2013. Source: Wikimedia Commons.

Image: U.S. corporate effective tax rates fell from 29% in 2000 to 17% in 2013. Source: Wikimedia Commons.

The architects of the proposal argue that the BAT would create a revenue stream of $1 trillion every decade. [4] As Auerbach argues, the BAT has a positive impact on tax revenue for two main reasons. Since the U.S. has a large trade deficit, the U.S. would gain more by taxing imports rather than exports. Secondly, the US would collect an increased stream of revenue from multinational companies, which would be greatly incentivized to expand production facilities in the United States. [5]

However, critics contend that the BAT is a direct tax on consumers. Since costs of imports would rise, the prices of consumer products would increase across the board. Indeed, companies that are import-heavy, such as retailers Walmart, Target, and Nike, vigorously oppose the tax, which would cause them to increase their prices. On the other hand, companies which are largely export-driven, such as manufacturing giants Boeing, Merck, and Dow Chemical, are lobbying in favor the BAT, viewing it as a way to expand their businesses abroad. [6]

The issue of the BAT has even split the Republican Party, causing senators Tom Cotton and David Perdue of Arkansas and Georgia respectively to pen a letter to the Republican leadership in the House charging that the Border Adjustment Tax is “regressive, hammers consumers, and shuts down economic growth.” [7] Even within the Trump administration, top White House aides to the President have been divided on the issue. White House Chief Strategist Steve Bannon is in favor of the proposal whereas Gary Cohn, the Director of the National Economic Council, is opposed. [8]

The political implications of the Border Adjustment proposal are stark. The U.S. Senate will use ‘budget reconciliation’ in order to pass the comprehensive tax reform package with a simple majority of 51 votes. However, budget reconciliation rules stipulate that the bill must be revenue neutral, i.e. it must not increase the deficit. Proponents of the BAT argue that this can be made possibly only through the $1 trillion in additional tax revenues from the Border Adjustment Tax.

Both sides of the debate point to different effects of the BAT to advance their respective arguments. Critics of the proposal argue that as prices of imported products increase across the board, inflation would increase and international supply chains would be heavily disrupted. However, supporters of the measure respond that aggregate demand would increase for U.S. exports, thus strengthening the value of the dollar. A stronger dollar consequently would increase demand for cheaper imported goods, and so the net effect on trade would be neutral. [9]

While solving some extant issues such as corporate profit repatriation, the Border Adjustment proposal of House Republicans creates problems of its own. Exporters are pitted against importers, and producers against consumers. While the tax is said to bring in $1 trillion in revenue over the next decade and to be potentially trade-neutral, the tax also has the potential to harm consumers and disrupt international supply chains. Consequently, the Border Adjustment Tax remains to be the greatest sticking point in tax reform negotiations.

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References:

  [1] Michelle Cottle, “Who’s Afraid of a Big BAT Tax?” The Atlantic, February 21, 2017, https://www.theatlantic.com/politics/archive/2017/02/border-adjustment-tax-congress/517287/.

  [2] Brian McGill and Richard Rubin, “What is the Border Adjustment Plan?” The Wall Street Journal, February 7, 2017, http://www.wsj.com/graphics/border-tax/.

  [3] Tim Parker, “Border Adjustment Tax,” Investopedia, June 07, 2017, http://www.investopedia.com/terms/b/border-adjustment-tax.asp.

  [4] Cottle, “Who’s Afraid of a Big BAT Tax?”

  [5] Alan J. Auerbach and Douglas Holtz-Eakin, “The Role of Border Adjustments in International Taxation,” Econometrics Laboratory at the University of California at Berkeley, December 2, 2016, https://eml.berkeley.edu/~auerbach/The%20Role%20of%20Border%20Adjustments%20in%20International%20Taxation%2012-2-16-1.pdf.

  [6] Cottle, “Who’s Afraid of a Big BAT Tax?”

  [7] Ibid.

  [8] Patti Domm, “Border adjustment tax is on ‘life support,’ and tax reform may come later … and with less punch,” CNBC, February 17, 2017, http://www.cnbc.com/2017/02/17/border-adjustment-tax-is-on-life-support-snagging-tax-reform.html.

  [9] Parker, “Border Adjustment Tax.”

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