January 31, 2017 3:06PM

Second Doubts about a Border‐​Adjustable Corporate Tax (BACT)

First Doubts” dealt with predictions that a 25% rise in the dollar could make a 20% tax on imports disappear with only temporary effects on trade but a $1.2 trillion increase in tax revenues (which would supposedly be paid by foreigners, and without complaint).  

Second Doubts will focus on a key claim that border adjustability is needed because “exports from the United States implicitly bear the cost of the U.S. income tax while imports into the United States do not bear any U.S. income tax cost.”   And we’ll question whether border adjustability is justified because corporate “cash flow” taxes under the House GOP plan are more like value-added taxes than corporate income taxes in other countries.

A Better Way” (a House Republican discussion document of June 24, 2016) says, “In the absence of border adjustments, exports from the United States implicitly bear the cost of the U.S. income tax while imports into the United States do not bear any U.S. income tax cost. This amounts to a self-imposed unilateral penalty on U.S. exports and a self-imposed unilateral subsidy for U.S. imports [emphasis added].”  

That statement makes the case for “border adjustment” – which means the costs of imports (unlike equivalent domestic costs) would cease to be tax-deductible for business and rewards from selling exports would cease to be taxable.  

Since all countries have corporate income taxes, what could it possibly mean to say only our own corporate income tax is an “implicit” tax on exports?  Who pays this “implicit” tax?

What could it mean to say that failure to impose U.S. income tax on foreign factories is a “subsidy to imports?"  

To claim U.S. exports “implicitly bear the cost of the corporate income tax” suggests the incidence of the corporate tax falls on consumers (foreign and domestic) in the form of higher U.S. prices.  Were it not for corporate taxes, the argument implies, cheaper U.S. exports could easily undercut the competition.  This is terrible economics. It makes no more sense that saying workers can avoid income and payroll tax by demanding a higher wage.

 The notion that businessmen simply charge extra to cover the cost of income taxes is rejected by all academic studies of who bears the corporate tax.  The Congressional Budget Office, for example, estimates that owners of capital bear 75% of the corporate tax and labor bears 25% through reduced productivity and real wages.  The Tax Policy Center estimates capital bears 80% of the corporate tax, labor 20% and consumers zero.  

The other Better Way complaint – that “imports into the United States do not bear a U.S. income tax cost” – is true yet strange.  It is likewise true that Australian imports of U.S. goods do not bear an Australian income tax. 

Corporations exporting from other countries have their own national income taxes to pay. It is bizarre to describe failure to tax profits of foreign firms as a “subsidy” to imports. Countries don’t tolerate foreign taxation of their businesses income unless occupied by a foreign army. 

Any alleged pro-import or anti-export bias of U.S. taxes clearly has nothing to do with corporate taxes, except that our high tax rate hurts business. But what about those Value-Added-Taxes (VAT) the border-adjusters seem to covet?

Just as all countries tax income of their corporations, all countries also impose “border adjusted” sales taxes on their consumers.  U.S. federal excise taxes and state sales taxes are border-adjusted just as foreign VATs are, and they bring in about 4% of GDP.  

VATs in Europe are typically near 10% of GDP.  But high taxes are nothing to envy.  Some our biggest trading partners collect only 5-7% of GDP from VATs – including Japan, Australia, Korea, Canada and Mexico.

Sales and excise taxes amounted to 3.7% of GDP in the U.S. from 2010-2014, according to the OECD, while Mexico’s VAT amounted to 4.6% of GDP.  Neither country imposes such sales taxes on exports, and both impose them on imports.  Yet Trump advisers complained, mysteriously, that Mexico’s VAT gave it some sort of unfair trade advantage over the U.S.

The House GOP plan tries to argue that two hoped-for changes in the corporate income tax – immediate expensing for investment and denial of interest deduction – magically transform their border-adjustable corporate tax (BACT) into a consumer sales tax, like the VAT.

 Tax Policy Center economist Bill Gale says the BACT “is essentially a value-added tax (VAT), but with a deduction for wages.”  No, it isn’t. 

A VAT taxes each firm’s revenue from sales minus the cost of goods bought from other companies.  Like a corporate income tax, by contrast, the GOP’s “cash flow” tax falls on revenue minus virtually all the usual business expenses except interest.  Call it what you like, this is essentially an income tax with a quicker write-off for capital investments (not land), and no deduction for interest expense (just as there is no deduction for dividends).  It’s no VAT.

Disallowing a deduction for imports would raise more tax revenue for the same reason disallowing a deduction for wages would raise more revenue. But for firms with high import costs, the Better Way tax bill could be higher than it is now, despite the deceptive 20% rate.

According to Carolyn Freund of the Peterson Institute, “The cash-flow tax proposed in the House is discriminatory. The tax on domestically produced goods would be less than the tax on imports, and it would vary across sectors. Unlike the sales tax, the cash-flow tax with border adjustment would favor domestically produced goods. In particular, it would have the odd feature that home goods would be taxed on total value added, less the wage bill; in contrast, foreign goods will be taxed on total value added.”  A football produced in the U.S. with imported leather would face a tax, while a football produced with U.S. leather would not.

Whatever the logic behind the proposed Border-Adjustable Corporate Tax (BACT), the politics of getting it enacted look doubtful.  What BACT economists dismiss as an ignorant belief that import taxes will injure import-dependent companies nevertheless motivates those companies to lobby hard against it.  And they include the largest private employers in the country, such as Wal-Mart and Target.

Regardless whether World Trade Organization official could be cajoled into approving this scheme (quite unlikely), what would our best trading partners say and do? Could anyone suppose Canada would sit back and smile if U.S. oil refiners had to pay 20% extra for Canadian crude?  Is Canada expected to feel happier about that deal if our greenback then rose 25% against the Canadian dollar?

This Border Adjustable Corporate Tax is not just a technical challenge for professional Treasury Department tax obfuscators, it would also pose huge diplomatic problems for the Commerce and State Departments.

Suppose the textbook model worked perfectly and the import tax and export subsidy left imports and exports just the same, sooner or later. Then why do it?  Because it’s a huge tax increase disguised as a tax cut.

Martin Feldstein has repeatedly advocated a lower dollar every couple of years, such as here and here and here.  Yet he now counts it a blessing that the dollar would rise by 25% with border adjustability. Why? He argues that because trade supposedly remains unaffected, the tax on U.S.  importers exceeds the subsidy to exporters, generating a huge tax windfall which is supposedly painless.   “Because U.S. imports are about 15% of GDP and exports only about 12%,” writes Feldstein, “the border tax adjustment gains revenue equal to 20% of the 3% trade imbalance or 0.6% of GDP, currently about $120 billion a year.” 

In the Feldstein view, future trade deficits are assumed stuck at 3% of GDP for a decade –regardless of tax incentives for investment or saving– and Congress is advised to use the BACT to manipulate the currency and thereby raise $1.2 trillion over a decade, ostensibly at other countries’ expense.

If the BACT shrinks the trade deficit as its supporters claim, then the Feldstein and Tax Policy Center estimates of a $1.2 trillion 10-year revenue windfall are wrong.  Proponents can’t have it both ways: The 20% tax or tariff on imports and matching subsidies for exports either reduces future trade deficits or it raises $1.2 trillion – it can’t do both.   

“The burden of the $120 billion annual revenue gain is not borne by U.S. consumers or companies,” says Feldstein.  That’s a hard sell for U.S. consumers and companies, and they’re unlikely to buy it.  

The corporate tax rate is much too high, producing nothing but corporate relocation, excess tax-deductible debt and accounting tricks to move expenses here and profits offshore. There is no need to devise bad tax increases to “pay for” a lower tax rate. Other countries collect much more revenue with much lower rates.  Try it. It works.

Keep it simple: Prioritize lower marginal tax rates on new investment.

Utopian tax reforms that become too pushy and divisive always fail.