is a director at Moody's Analytics in West Chester and an adjunct professor of economics at Villanova University
The fight over a border adjustment tax is on in Washington and on Wall Street, but most of Main Street continues to wonder what exactly a border adjustment tax is, and why the heck they should care about it.
What is a border adjustment tax? To understand that you need to first understand how companies are already taxed.
A tremendous number of factors go into determining a company's tax liability, but essentially this boils down to subtracting costs from revenues. Whatever money is left over is profit, and the company pays federal income tax on that profit. Costs include the costs of goods and services a company uses to make what it sells. Take the pen I'm using to write these words (yes, there are still people who write with pen and paper).
I bought this pen from a big-box retailer, and the label on the side of the pen tells me it was made in China. When the retailer filed its taxes last year, it subtracted the cost of the pen it bought from a company in China from the amount of money I paid for the pen. It then paid U.S. federal corporate income tax on what was left over in profit.
A border adjustment tax would change that math.
Under a border adjustment tax, firms would only be able to deduct the costs of goods produced here in the United States. So in the case of my pen, the big-box store would have to pay tax on all of the money I paid for the pen, not just the difference in what I paid and the store's costs. What's more, goods that are produced by U.S. producers and exported overseas would not be taxed at all.
This, under the full House Republican plan, would essentially make imports from overseas 20 percent more expensive. The idea is that this would help make U.S. producers more competitive with their foreign rivals, and incentivize stores to try to sell me a pen made in the U.S.A.
So what does this all mean? It means that it will be a lot more advantageous to be a business that exports U.S. goods and services overseas. This is great if you work for a U.S. manufacturer that works with a lot of overseas clients. It's no wonder that companies like Boeing, GE, and Caterpillar have already come out in strong support of a border adjustment tax.
However, it also means that it will be much less advantageous to be a business that imports overseas goods into the United States. Higher costs for retailers mean higher costs for American consumers. Think of all the goods we buy on a weekly basis, including my pen, that are not made in the United States from retailers like Wal-Mart, Target, and others. These types of companies have, unsurprisingly, voiced their displeasure with the new tax proposal.
Assuming all of this complies with World Trade Organization regulations, which is a big assumption, these will be the immediate winners and losers of a border adjustment tax. But over the long run the impacts will be less severe. Why? Because markets adjust.
In this case proponents of the border adjustment tax argue that currency markets are likely to adjust, pushing the value of the U.S. dollar much higher, and making those same imports, like my pen, less expensive in the long run. In theory, this should all net out for consumers in the end. In practice, however, things are likely to be a bit messier.
The implementation of a border adjustment tax could be a net positive for the United States long term, but there would likely be a lengthy transition period as markets adjust. During that time things are likely to get especially rocky for U.S. retailers, and in turn U.S. consumers. What's more, there are other side-effects of an exceptionally strong dollar to keep in mind, and not all of them are a positive for the U.S. economy.
If this seems complicated, it's because it is, and unfortunately as it often does, injecting politics into this situation only makes things even more complicated. The prospects of such a rocky period for consumers has obviously been a big stumbling block for many politicians on both sides of the aisle. So why bother with such a complicated tax proposal in the first place?
Republicans in Congress and President Trump ran on a platform of tax reform, especially corporate tax reform, and with good reason. Our current tax system is ripe for major improvements. Our corporate tax rate is one of the highest in the developed world, and the spider web of loopholes and distortions in the tax code has grown in size since our last major effort at tax reform way back in 1986.
From a political standpoint, tax reform must be addressed in the next two years, and we find ourselves in a position where that reform cannot happen by adding significantly to the deficit.
Our national debt has risen by more than $9 trillion, or 86 percent, in the last eight years, and now sits at its highest level since WWII. No matter what mess policymakers find themselves in we are well past the point where we can borrow our way out of it, and deficit hawks in Congress are rightfully less keen to go along with any tax cuts that are not paid for.
As a result, simple tax cuts are out of the question, which is why the border adjustment tax was proposed in the first place. In a country with a large trade deficit, such as the United States, a border adjustment tax can be a big revenue raiser. The Tax Policy Center scores the proposal as generating as much as $1.2 trillion in new federal tax revenue over the next 10 years that can be used to offset lower tax rates.
This has become so ensconced in the idea of tax reform in the House that the fates of the two proposals have become almost inseparable. A border adjustment tax cannot pass without lower corporate tax rates and, more important, lower corporate tax rates may not be able to pass without the revenues generated by a border adjustment tax.
As a result, policymakers are at a difficult impasse, which, regardless of its complexity, we should all be very much paying attention to.