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Phil West on International Tax

Straight Talk on Border Adjustments: What Are We Really Talking About Here?
December 5, 2016

The election makes it more likely we will see major tax legislation enacted.  Not only has there been major tax legislation enacted relatively early in the terms of most recent new presidents, but the common control of the executive branch, Senate, and House by Republicans makes major tax legislation even more likely.  The most likely starting point for the legislation that is ultimately enacted is the June 2016 report issued by House Ways and Means Republicans (the Blueprint).

The Blueprint states: “This Blueprint eliminates the existing self-imposed export penalty and import subsidy by moving to a destination-basis tax system.  Under a destination-basis approach, tax jurisdiction follows the location of consumption rather than the location of production.  This Blueprint achieves this by providing for border adjustments exempting exports and taxing imports, not through the addition of a new tax but within the context of the transformed business tax system.  The Blueprint also ends the uncompetitive worldwide tax approach of the United States, replacing it with a territorial tax system that is consistent with the approach used by our major trading partners.”  The Blueprint mentions border adjustments with respect to products, services, and intangibles.  This analysis focuses on adjustments for goods.

Numerous claims have been made about border adjustments, including that they will benefit US companies compared to other companies (or at least remove a disadvantage for US businesses), will benefit exporters compared to importers, and will help US business become more competitive.  A few facts will help us understand and evaluate border adjustments.

Other countries have border adjustments because other countries have taxes we do not have.  Border adjustments are an element of valued-added taxes (VATs) and other consumption taxes, which the vast majority of other countries have but we do not, in addition to the income taxes that they have and we have.  (We have consumption taxes at the state and local level, and excise taxes, which are a form of consumption taxes, at the federal level, but let's keep it simple and talk about the federal income tax, since that is what is likely to change and that is where the border adjustment debate is taking place.)

The purpose of those border adjustments is to make sure that the consumption taxes of which they are a part actually tax consumption, and tax it only once.  You can imagine a consumption tax on goods that cross a border being imposed both by the country where the goods are exported from and the country where the goods are imported to.  Border adjustments allocate the tax to the country where the goods are imported to (the country where the goods are consumed) by ceding the tax from the export country to the import country.

But again, this allocation of consumption taxing rights to the import country operates where there is a consumption tax to begin with, and the US does not have one.  So what gives?  Well, the idea is to add a border adjustable feature to our current income tax, but change the current income tax so it looks more like a consumption tax.  There are at least two important reasons to do it that way.

First, a Republican tax plan will not add a new tax, so the way to do it is change a current tax.  Second, border adjustments are less likely to violate our trade rules if they are part of a consumption (indirect) tax, so making our current tax look more like a consumption tax makes the border adjustment feature more likely to survive.  (The question is whether we can make our current tax look enough like a consumption tax to do the trick.  And, even if not, what the consequence will be and how long it will take to resolve the issue.)

Now let's consider the consequences of a border adjustment.  First, we do not know the specifics of how the current tax will be changed, so we do not know the consequences of the new tax system onto which the border adjustment will be grafted.  It is at least possible, though, and perhaps likely, that the consequences of the other differences in the tax will have a greater impact on US businesses than the border adjustment feature.

Second, US businesses (and foreign owned businesses) both import and export.  This means that it is too simplistic to conclude that (a) US-based businesses will benefit compared to others, or (b) all US businesses will be of the same mind about a border adjustment.  Each one will have to figure out whether the border adjustment will be a net plus or a net minus.

Third, most economists think that exporters ultimately will end up not being benefitted by a border adjustment because other elements of the economy will adjust, most notably currency exchange rates.  Of course, the politics of the border adjustment may swamp the economic theory, and this near-consensus may become background noise, but it should nevertheless inform those whose job it is to evaluate the border adjustment and decide how much effort to spend supporting or opposing it.