President Donald Trump expressed concern in his address to Congress Tuesday over how imports are hardly taxed, but domestic production is. Coupled with broad tax reform, a border adjustment tax has been proposed as a way to change the uneven international playing field.
House Speaker Paul Ryan and Rep. Kevin Brady proposed a blueprint last year with the goal of overhauling the tax code. The blueprint is designed to create a more competitive system that spurs economic growth by simplifying the tax code and lowering rates. It also includes a border adjustment tax.
“American companies are taxed at one of the highest rates anywhere in the world,” Trump said during a joint congressional session Tuesday. “When we ship products out of America, many other countries make us pay very high tariffs and taxes — but when foreign companies ship their products into America, we charge them almost nothing.”
The plan hasn’t been written into legislation yet, and there are still plenty of details to work out. A major piece of the plan that has sparked an intense debate is the border adjustment tax. Here is everything you need to know about that proposed tax.
What Exactly Is It
The border adjustment tax is a value added tax levied on imported goods. Basically, the tax is applied when a product is produced in a foreign country but sold in America. Additionally, the company will be unable to deduct the cost of importing that good as a business expense, which is currently allowed.
“Border adjustments mean that it does not matter where a company is incorporated,” the blueprint details. “Sales to U.S. customers are taxed and sales to foreign customers are exempt, regardless of whether the taxpayer is foreign or domestic.”
A border adjustment tax is also known as a destination-based cash flow tax. A destination tax is concerned with where a good travels to be sold. An origin tax, in contrast, is merely concerned with where a good is produced. A border adjustment tax would mean a company would still be taxed even if the good is produced in another country.
A cash flow tax measures the financial performance of a company, and its ability to generate cash flow. Companies are currently taxed on their worldwide profits at 35 percent. A border adjustment tax would essentially prioritize domestic production by lowering the tax rate for exports while increasing the rate for imports.
What It Would Look Like
An automaker, for example, might choose to move its production of cars to Mexico. The company might be seeking out a lower tax burden as well as lower labor and regulatory costs. Under the current system, that company would not be taxed for goods sold domestically because its production is elsewhere.
A border adjustment tax could completely change that. The automaker would be taxed regardless of where its production is because it imported cars to be sold domestically. A competitor, however, wouldn’t face the same tax if it produces and sells cars domestically.
Part of a Bigger Tax Plan
The border adjustment tax is a part of a much larger plan to overhaul the tax system. The Republican blueprint is designed to simplify the tax code and reduce rates. The hope is to consolidate the system down to three tax brackets and lower the top individual income tax rate to 33 percent.
“It’s not like you start with the border adjustments, and say let’s build up a system around that,” Carnegie Mellon University Prof. Jeff Kupfer told InsideSources. “You begin with the premise of we want to reform our corporate tax code because it’s outdated and anti-competitive and everything else, and then you begin to move from there and think what type of corporate tax system do we want.”
The plan would also lower the corporate tax rate to spur economic growth. The blueprint also streamlines college tax benefits, changes dependent tax credits for families, and reforms savings provisions for retirement. The goal is to have a plan so simple and fair it could fit on a postcard.
“We are fully supportive of comprehensive tax reform,” Americans for Prosperity senior policy analyst Mary Kate Hopkins told InsideSources. “We’re really excited to see the House, the Senate, and the White House are making this a priority. We’re excited by the idea of lower rates, broader base, simpler system, all these are great things.”
Keep Companies in the Country
President Trump and others also see border taxes as a way to keep companies in the country. The border adjustment tax may disincentive companies from moving their production elsewhere. Kupfer notes companies would no longer be able to avoid taxes by moving overseas.
“There’s less of an ability and incentive for companies to try to shift their production overseas,” Kupfer said. “What you’re focusing on is where the good or the service is consumed, and if it’s consumed in the United States, then it’s taxed in the United States.”
Those opposed to the border adjustment tax argue there is a better way to keep companies from fleeing. The current system imposes many tax and regulatory burdens on businesses that may force them to seek out a more competitive economy. It may be enough to just decrease those burdens.
“I think the absolute best way to keep companies here is to have a tax and regulatory regime that makes it easier to do business here,” Hopkins said. “American companies want to be headquartered here, they want to do their business here. We have a strong dollar, the rule of law, its close to where they live. So the best way to do that is to have the lowest tax rate for corporations in the world, and to have a regulatory system that makes it easy to do business.”
Make Up for Lost Revenue
Republicans hope to make major cuts to the tax system as part of their overhaul plan. The lower rates, however, would mean a lack of revenue to fund government expenses. The lost revenue could drastically increase the deficit which would severely worsen the debt problem. The border adjustment tax could offset the lost revenue without forcing drastic government cuts as Trump begins to implement his agenda.
Border adjustment tax critics, however, argue there is a better approach. Republicans could instead look to cut government spending to make up for the lost revenue.
“We would definitely be in favor of cutting government spending as opposed to hiking a tax on American consumers,” Hopkins said. “Republicans have been running for years on tax reform and limited government, and when you have the opportunity to tie those two things together, tying a great tax reform package with spending cuts, why would we not take that opportunity.”
Concern for Consumers
The economy is increasingly moving towards a more competitive global market. New technologies and trade deals have made it easier to move business operations overseas. Those opposed to the border adjustment tax fear the increased rates on imports will ultimately be felt by domestic consumers.
“It will be collected by the businesses in the form of a corporate income tax,” Hopkins said. “But that will be passed onto consumers who will end up paying more for everyday items, many of which they can’t afford to pay 20 percent more for.”
Hopkins adds the policy will ultimately become a $1.2 trillion tax increase on consumers. Corporations that import goods would essentially be left with few options but to shift the burden onto their customers.
Shifting the Tax Burden
Supporters of the border adjustment tax counter the harm to consumers would be mitigated. The blueprint would end up increasing taxes on imports, but it lowers corporate rates elsewhere. It essentially shifts some of that tax burden.
“I think they need to keep in mind it goes along with a much lower tax rate that they’re going to see and a variety of other things,” Kupfer said. “No matter how you look at it, it’s going to be beneficial for them. Companies and others need to keep it in the broader picture.”
Kupfer adds it’s only natural that companies are going to try to predict how it is going to impact them. He urges them, however, to look at what the plan is trying to accomplish as a whole. Hopkins counters that the border adjustment tax will still be problematic, even with the lower rates elsewhere.
“Even though the overall corporate tax rate would be cut, the increase in taxes on importers would cause their marginal tax rates to soar,” Hopkins said. “When they can no longer deduct the cost of their foreign inputs, they will be paying taxes on more money than they are actually bringing in. So that’s where the tax hike comes in, and it will be felt by consumers regardless of the overall corporate tax cut.”
Hopkins adds there are also many companies that primarily import goods. Those companies will not have their expenses offset by the lower corporate tax rate.
The Likelihood It Will Pass
The border adjustment tax is facing some opposition on Capitol Hill. Republican Sen. Tom Cotton and a few other GOP members have expressed concern over the border adjustment tax portion of Ryan’s plan. Many members, however, have yet to take a firm position.
Americans for Prosperity (AFP), part of the network funded primarily by the Koch brothers, and other outside groups have openly opposed the idea. The AFP considers its opposition to the border adjustment tax to be a top priority. It has launched a digital campaign and is helping to mobilize grassroots opposition.
The border adjustment tax is still receiving plenty of support from American business. The American Made Coalition, among others, have defended it by arguing it will help the economy by keeping jobs in the country.
Lawmakers are rarely ever able to overhaul the tax system because it’s a complicated endeavor. The last major tax reform came in the 1980s. Nevertheless, the president and congressional leaders have made it a priority which is driving optimism among supporters.
“I give that a fairly strong likelihood because I think that all the forces that need to be in play to push through tax reform are in play now,” Kupfer said. “I think the forces are aligned to make something happen. The specifics of it are harder to predict in terms of exactly what’s going to shake out.”
The question then becomes what exactly those reforms will look like. The border adjustment tax and other major provisions might not make it into the final law. The details still need to be worked into legislation, and once a bill is drafted it’s likely to face debate as it works its way through the legislature.
“There is an awful lot of skepticism, particularly coming from the Senate,” Freedom Partners Spokesman Bill Riggs told InsideSources. “People are still in the education phase about the impact of this tax but when you’re talking about a $1.2 trillion tax hike that’s going to be felt largely by consumers, and could take away as much as $1,700 from the average family savings, that’s clearly going to be a cause for concern for a lot of people on the hill.”
The Annenberg Public Policy Center has called into question that $1,700 figure. It argues on its fact-check website that the net cost of imports would be unchanged because the dollar would strengthen against other currencies. It points to some economists who have concluded as much.
Public Opinion on Border Adjustment
While it’s not yet clear how voters will react to the full tax plan or the border adjustment tax, new polling this week helps to shed some light. A poll conducted by the American Action Network found that more than three-quarters of registered Republican voters consider tax reform a top priority, and 85 percent agree with the broad principles of the tax plan.
When American Action Network asked about Republicans’ top goals for tax reform, they prioritized: “make it easier to create jobs, raise wages, expand opportunity” and “a tax code that grows the economy, encourages job creation.”
Additionally, while the survey found Republicans believe businesses will benefit from tax reform, it also found Republicans expect individuals to benefit from lower rates and a simplified system.
The American Made Coalition, which supports border adjustment, also released polling this week. It found that 58 percent of voters, including majorities of Republicans and independents, support the outline of the border adjustment tax to lower taxes on exports and raise taxes on imports. The survey also revealed: “Regardless of party affiliation or registration, voters strongly prefer a tax code that incentivizes American manufacturing over one that incentivizes foreign goods imported for lower prices.”
An Efficient System
Border adjustment tax supporters see it as a more efficient system. They believe it will ultimately be easier to impose taxes on where goods are sold as opposed to where they’re made.
“Are you looking at domestic consumption as your taxable event or you’re looking at your domestic production as your taxable event,” Kupfer said. “The destination basis is a much more effective and efficient way of applying the tax for a variety of different reasons including the ease of administration, that’s the primary one I look at.”
The Hope for a Stronger Dollar
Border tax supporters are also hopeful the dollar will strengthen in the new system. A stronger dollar in the international markets will ultimately yield positive results for domestic businesses and the local economy.
“Like a lot of things in economics and tax, you can’t ever be a hundred percent sure of anything,” Kupfer said. “But you do have plenty of very credible economists who describe the mechanism that should take place if this type of proposal is implemented in that worldwide exchange rates and the evaluation of the dollar will adjust.”
Those opposed, however, argue economists cannot be completely certain how the dollar will react. It might take a time to adjust, and might not adjust fully to the new system.
“There’s really no way of predicting how the dollar is going to react to a border adjustment scheme,” Hopkins said. “It might appreciate upwards, but we can’t say it will appreciate quickly or completely to offset this tax.”
Transitions to Ease the Burden on Businesses
There are avenues lawmakers could explore to mitigate any potential problems the border adjustment tax might cause. The final legislative language, for instance, could include an adjustment period for businesses. They would then have time to transition into the new system.
“One can’t be sure of anything and how quickly some of those adjustments may occur and so transitions rules could be written into the proposal so that some of the changes can be implemented over a number of years,” Kupfer said. “That will allow adjustments to occur in a way that may not cause as much disruption as could possibly occur otherwise.”
Hopkins counters that a transition period isn’t a great idea either. She notes that transitions and special carve-outs for certain companies will start to look like the current system. The blueprint, after all, is designed to simplify the tax code.