January 25, 2017 / 4:00 PM / a year ago

Breakdown: Border tariff vs. border-adjustment tax

WASHINGTON (Reuters Breakingviews) - There’s a lot of talk these days about borders and taxes in Washington. U.S. President Donald Trump wants to hit firms that outsource with a simple tariff on imports. Republicans in Congress have pitched a more complex idea, a border adjustment, built into a corporate-tax overhaul. Breakingviews ticks through the winners and losers.

A man touches the double steel fence that separates San Diego and Tijuana at the border in Tijuana December 10, 2011. REUTERS/Jorge Duenes

WHAT IS TRUMP‘S TARIFF PLAN?

Angered over companies setting up factories in Mexico and elsewhere to produce goods for the U.S. market, as well as by those who already manufacture outside the United States, the president has threatened to impose a penalty in the form of a tax at the border. The levy, which he has suggested could be as high as 35 percent, would apply to firms that import goods to the United States. On Monday, he reiterated his threat to impose a “very major” border tax during a meeting with manufacturing executives. Separately, he’d also reduce the standard corporate tax rate to 15 percent from the current 35 percent.

HOW DOES THAT DIFFER FROM THE HOUSE REPUBLICAN PLAN?

Trump’s particular target is U.S. companies that don’t manufacture in America, and it’s unclear how widely his punitive levy would, or could, be applied. But he’s painted it as a simple border tariff. Lawmakers led by House Speaker Paul Ryan, on the other hand, would include border adjustments in a broader revamp. They too would cut the typical corporate income tax rate, to 20 percent in their plan. And they’d move toward a territorial system in which companies would be taxed where income is earned.

The cost of imported parts or finished goods for use or sale in the United States would no longer be deductible for tax purposes, while revenue from exports would be excluded from taxable income. The idea, House Republicans say, is to reduce incentives for companies to play games with the prices at which they move goods between jurisdictions or to move their headquarters abroad to reduce their tax bill. Currently, a U.S. company’s overseas profit is taxed at home (often in addition to incurring tax overseas) but only when the money is brought back to the United States. Export revenue and import costs are both included in calculations of U.S. tax liabilities.

In an interview, Trump told the Wall Street Journal that such a tax is too complicated, though he later said he would work with congressional GOPers.

IS IT REALLY THAT COMPLEX?

In some ways, yes. Companies would have to rethink their tax strategies based on evaluating a tax cut versus the higher cost of imports which would no longer be deductible. There’s also a debate over whether it would violate World Trade Organization rules. These permit border adjustability for indirect levies like value-added taxes, but a direct tax, like one on income, may be prohibited, as are many export subsidies.

Technically, a border-adjusted tax isn’t considered a VAT because wage expenses aren’t deductible. That deductibility does apply to domestic goods under the U.S. tax code, which adds another consideration for companies.

WHO STANDS TO WIN AND LOSE?

Both Trump and Republicans in Congress say they want to encourage domestic manufacturing. Trump’s blunt approach would not only almost certainly fall foul of WTO rules, it could impede the flow of trade significantly, especially if other countries impose tit-for-tat levies. Proponents of border adjustments claim their approach levels the playing field for companies that choose to make goods in the United States by ending double taxation including on their exports. Many other nations exempt exports from VAT but impose it on imports. There’s also less risk of retaliation than with Trump’s tariff idea.

But the benefits and costs are uneven. Retailers selling imported products, like clothes, shoes and electronics, say the border-adjusted tax would increase their costs - which rings true, since some would essentially be taxed on something close to their revenue, rather than their profit, outweighing the benefit of a lower headline rate of tax. The National Retail Federation says the idea would force its members to raise prices for consumers by up to 15 percent. Other industries that rely on imported parts, like the auto sector, could be hurt, too. Gasoline prices could also go up since the tax would apply to oil imports.

Conversely, big exporters including giants like Boeing could benefit disproportionately, while purely domestic U.S. concerns would gain simply from the lower headline tax rate.

Advocates of the House plan say any costs associated with a border-adjusted tax would be countered by a rise in the U.S. dollar, which could occur as demand for imports theoretically falls. But that’s a big “if” given the myriad other factors that influence exchange rates.

WHAT ABOUT THE REPUBLICANS’ CONCERN ABOUT GOVERNMENT SPENDING?

That’s at the heart of the proposals the GOP made. Cutting the corporate tax rate will cost the government badly needed revenue. Fiscal conservatives in Congress like Ryan are reluctant to make such a move without raising money elsewhere. The border-adjusted tax would bring in more than $1 trillion in federal revenue over a decade, according to the Tax Foundation, helping to close the gap. For the first time since 2009, the U.S. deficit increased as a share of economic output in 2016, hitting nearly $600 billion or 3.2 percent of GDP. The Congressional Budget Office said on Tuesday that debt held by the public is projected to rise to nearly 90 percent of GDP in 2027 from 77 percent currently.

New revenue from Trump’s blunt tariff is much less predictable, because it could simply discourage trade altogether. However, Trump’s “America first” emphasis means that Republicans aren’t as keen to talk about the perceived dangers of government deficits as they used to be.

ARE THERE ANY OTHER IDEAS?

If the White House and Congress can’t agree, Ryan and his allies will still probably want to find ways to raise revenue in other ways if they lose it by cutting the corporate tax rate. One option tried out in the UK is a tax on the banking industry, perhaps a levy based on total liabilities.

Whichever way they go, it’s difficult for Trump to unilaterally impose taxes and he needs congressional buy-in. Just like the border adjustments favored by Ryan et al, it’s not likely to be as simple as the president would like.

Breakingviews

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