“Terrible idea,” or a way to rebalance American trade? Donald Trump and Republicans in Congress are working on a “border tax adjustment” bill to boost exports while penalizing imports, mainly through the tax system. The BTA would disallow deductions for costs when calculating profits on imports, but would give exporters a significant cost-deduction benefit while calculating profits. Former Reagan adviser Martin Feldstein insists that this will boost the dollar and create significant new tax revenues, which will help balance the trade deficit and reduce budget deficits.
Not everyone agrees with how the BTA will work, nor on its effects. Feldstein defended it on Bloomberg earlier this week:
Feldstein remarked that his critics don’t understand how the BTA will work. Economist Ray Keating argued in RealClearMarkets yesterday that Feldstein and Republicans don’t understand how VATs work with our trading partners, and that the BTA will damage our own position as exporters. Keating calls this a “fake issue” and the BTA a very bad solution to a non-existent problem:
From this mistaken concern over trade deficits has come the idea that the U.S. needs to make border tax adjustments like other nations. The argument goes that these countries provide rebates for their value-added tax for exports, while imposing the VAT on imports from the U.S. This, the argument goes, is unfair, and puts the U.S. at a disadvantage.
The obvious problem with this argument is that it ignores why these border adjustments occur, and ignores the fact that the U.S. does not impose a VAT (thankfully!).
A border VAT adjustment is not a nefarious tool, but instead, a straightforward measure that places competitors on equal footing in terms of tax treatment. Consider that a nation like Mexico that imposes a VAT on domestically produced goods (imposed at each stage of production) will adjust or remove the VAT for exports and impose the VAT on imports. In this way, domestically-produced goods and imports receive equal treatment in the Mexican market. Meanwhile, if Mexico is exporting to another country with a VAT, that nation’s VAT will be imposed at the border. In the case of the U.S., again since we impose no VAT, there is no border tax applied. Therefore, Mexican exports to the U.S. are treated the same as domestically-produced goods.
That’s it. It’s really a non-issue. But now it’s a fake issue, as the idea of a border adjustment for U.S. corporate income taxes has entered the tax reform debate, that is, not taxing exports but taxing imports. This ignores several more facts. First, the WTO does not allow for border adjustments on income taxes. Second, most other nations impose an income tax and a VAT, and since the U.S. does not inflict a VAT, this is a tax advantage for the U.S., as opposed to a disadvantage. Third, emphasizing the fake issue of a border tax adjustment actually lays the groundwork for the U.S. imposing a VAT – which would be an actual and significant negative for the U.S. economy.
Steve Forbes also hates the BTA, and wonders how many Republican voters grasp the scope of the policy. Not only will this drive up prices almost immediately, it would be a huge boon to the largest players in each market, wiping out the tax basis for their exports and creating the potential for write-offs that could eliminate their overall tax bill:
Few people are even aware of what the Republicans are getting ready to hit them with. There has been virtually no debate or public discussion about this new, horrible tax, yet in one of those strange fits of collective, self-destructive behavior, numerous GOP lawmakers are ready to enact it.
Here’s how, in essence, this sneaky, anti-consumer tax works. Importers will no longer be allowed to deduct an item as a business expense. To simplify things, let’s say a store imports a pair of sneakers for $40 and then sells them for $50, making a $10 profit on which it would owe taxes. Under the Republican plan, however, the retailer wouldn’t be able to deduct the $40 it paid for the sneakers. In fact, it would owe taxes on the entire $50! And who, ultimately, pays this tax? You, the consumer, in the form of higher prices or fewer choices of where you can shop. Retailers and their customers will be hit. …
But wait, it gets worse. Another feature of this bizarre GOP scheme gives exporters a gargantuan tax break by, in effect, not taxing their export revenues. Let’s say a corporation sells a piece of machinery to Iran for $5 million, which cost only $4 million to produce. That means $1 million in taxable profit. Under the new Republican scheme, however, that $5 million received from the mullahs wouldn’t be taxable. Instead of a $1 million profit, the corporation, for tax purposes, would have a $4 million loss. Loophole doesn’t begin to describe this “tax break.”
No wonder companies like Boeing, GE and other big exporters are orgasming over this GOP “reform.”
Interestingly, Trump campaign economic adviser Larry Kudlow has come out in opposition to the BTA as well. Kudlow wants broader reform of the corporate tax code, and worried that the BTA could “doom” those efforts. Rep. Devin Nunes (R-CA) argues that the BTA will encourage investment and avoid VATs and tariffs, but Kudlow’s not buying it:
“I think this is a very simple way to border-adjust. It’s not a VAT (value-added tax). It’s not a sales tax. It’s not a tariff. We want to have business taxes completely revamped in this country because we want to encourage people to invest in the economy so that jobs can be created,” Nunes said. “We can get out of debt financing and into equity financing, so it’s a plan that will really make America great again.”
However, CNBC contributor Larry Kudlow vigorously disagreed with Nunes, saying that border adjustment unnecessarily complicates corporate tax reform efforts — possibly derailing them completely. It could even impair economic growth, he said.
“To renegotiate this into some kind of border adjustment, which will penalize imports and subsidize exports, that is an exercise in government planning and complexity that I believe is doomed to fail,” Kudlow said. “And if you stay with this, congressman, the whole corporate tax reform thing — the most important pro-growth measure — goes down the drain over this.”
Kudlow makes a good point about the issue of dealing with individual problems with systemic changes. Perhaps the better approach would be to pressure Mexico into adhering to its original agreement on VAT adjustments — and that may be what Trump intends to do, using the BTA as a big stick to force Mexico into negotiations. If so, then fine, but putting this into law makes it more difficult to get real tax reform down the road, as Kudlow warns here.
The problem with our tax codes now is that they are already far too complex, and that complexity serves two constituencies: Congress and their zeal for social engineering, and large corporations who use its compliance costs as a competitive advantage over smaller entities. The path to real growth is in simplification and fair application of law and regulation, not more complexity and higher compliance costs, with special carve-outs to lobbyist-heavy industry giants. This is a gigantic step in the wrong direction, if it’s not a bluff.