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House GOP Makes the Case for Border-Adjustment Tax

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Mar 22nd 2017
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With tax reform still very much in play, the Tax Foundation has joined the discussion with a report that explores border adjustment and its possible implementation problems.

Border adjustment is a key aspect of the tax plan rolled out by House Republicans in June 2016. The plan seeks to lower the corporate income tax rate to 20 percent and modify it to what’s called a destination-based cash-flow tax (that applies to the consumption of goods and services in the United States) instead of an origin-based tax (that applies to the production of goods and services in the United States).

As part of that plan, border adjustment would apply that tax to imports but not exports. US businesses wouldn’t be able to deduct import costs and they wouldn’t be taxed on exports.

The switch, then, is trade-neutral, the report states. It doesn’t change the trade balance and doesn’t create an advantage or disadvantage for the United States.

“When the border adjustment is applied, either the US dollar would appreciate or the domestic price level would increase, so that imports and domestic goods remain on an equal footing compared to current law,” the report states.

The concept may be new as a business income tax but the actual application of border adjustment has been in use since the 1860s and is common worldwide, according to the report.

“Many retail sales taxes in the United States are destination-based and have border adjustments, and most value-added taxes throughout the world employ border adjustments,” the report states.

Further, border adjustment would prevent profit shifting, do away with the need for anti-base erosion provisions, and broaden the tax base within the budget time frame, the report states.

“Although there are no expected trade-related economic gains from implementing a border adjustment, there are advantages to this approach, especially in limiting tax avoidance and simplifying certain aspects of the code,” said Kyle Pomerleau, director of federal projects at the Tax Foundation, who authored the report.

Under the House Republicans’ plan, the border adjustment would raise more than $1 trillion in revenue over the next 10 years, which could fund other provisions. That’s because the United States now runs a trade deficit of about $500 billion, meaning that imports taxed under a destination-based tax exceed exports, which are exempt, the report states. It’s worth noting, however, that if the trade deficit becomes a trade surplus, that revenue bump goes away.

But Pomerleau also indicates that border adjustment likely will face challenges. It’s not clear if it would comply with rules under the World Trade Organization (WTO). It also could overtax exporters in some situations and pose transition problems.

Overall, though, Pomerleau believes the border-adjustment proposal “is a serious policy worthy of consideration.”

Here’s a closer look at some of the potential obstacles, according to the report:

WTO. Current WTO rules could consider the border-adjustment tax plan as an unfair trade advantage for the United States.

The rules allow for border adjustments on imports and exports, but they typically are allowed under an indirect tax, like an excise tax, and not on a direct tax, which a corporate income tax is. A tax with a border adjustment could be considered discriminatory against imports if domestic and foreign goods aren’t treated equally. And exports can’t get a bigger tax rebate than the tax levied if the same goods were in the domestic market.

How it’ll work. Taxes paid on imports need to be directly offset with an equal exemption for exports. But it’s not clear if the House GOP proposal will work that way, and it’s possible exporters could face a competitive disadvantage.

It’ll also be tough to ensure that all direct foreign sales to consumers are taxed.

Transitions. How soon will prices adjust to the new destination-based tax? Until that happens, the tax could fall on consumers and producers.

Foreign assets held by Americans would decline in value because of the appreciation of the dollar. People with investment returns in Euros would see declines after the appreciation. But residents of other countries who own US assets would see higher returns.

“It’s important to note that while this hit to wealth due to the border adjustment is real, the broader GOP plan would permanently boost Americans’ incomes at the same time,” the report states.

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