President Trump’s desire to fund the cost of a wall across the southern border with Mexico has suddenly brought out of obscurity a border-tax idea that has been around for many years and is embedded in the
The plan would subject importers to higher taxes than exporters or those that produce at home for domestic consumption.
But the proposal — which would essentially replace much of the current corporate tax system — is so fraught with controversy and challenges, politically and legally, that many experts give it long odds of being adopted, despite strong backing from House Speaker Paul D. Ryan (R-Wis.) and House Ways and Means Committee Chairman Kevin Brady (R-Texas).
Trump himself had initially dismissed the idea as too complicated, but Thursday he and administration officials suggested that they were considering a 20% tax as an option to generate revenue from imports from countries such as Mexico to pay for the wall.
Although it wasn't entirely clear what kind of tax the president had in mind, it appeared Trump was opening the door to a so-called border-adjustment tax, also referred to as a destination-based tax because the taxes are determined by where the goods and services are sold.
Under such a proposal, a company that imports all of its goods would face a 20% tax on sales of those goods in the U.S.
By contrast, a business that produces and sells only in the U.S. could reduce the 20% tax bite substantially because it would be able to deduct the labor costs incurred domestically that went into the products.
Most to gain are exporters: A company in the U.S. that produces at home would be exempt from paying the tax on its foreign revenue, and moreover it could deduct the domestic labor costs for those goods or services sold. That means a profitable export business could even wind up with a negative tax liability, thus a refund.
"The export rebates will end up being politically problematic because it will involve the Treasury sending checks to profitable companies instead of collecting taxes from them," said Eric Toder, a former Treasury official who co-directs the Tax Policy Center. "And I don't think the optics of that would go over very well."
Many economists like the proposal because it is simpler than the current tax code, which has a high 35% tax rate and is also teeming with special deductions and loopholes.
Significantly, the import tax would sharply reduce, if not eliminate, incentives for multinational firms to relocate headquarters outside of the U.S., a practice known as corporate inversion, or to manipulate the tax system in other ways to shift their profits offshore to avoid U.S. paying taxes.
"It will strongly encourage companies to locate production activities in the United States because the taxes paid on profits are going to depend on where they're sold, not where they're produced," said Alan Auerbach, a professor of economics and law at UC Berkeley who has written about border-adjustment tax over the last decade.
Based on a 20% tax, the proposal in itself would generate more than $1 trillion in tax revenue over 10 years. But the border-adjustment tax is only part of a comprehensive tax overhaul plan by House Republicans, which includes substantial cuts in individual income taxes, largely benefiting higher-income Americans. On the whole, experts say, the House tax reform would reduce federal tax revenue overall, even with the gain from the border-adjustment tax.
The proposed tax faces opposition from many camps, liberals who don't like the seemingly regressive nature of a consumption tax, and fiscal conservatives. Some of the most vocal critics are large importers such as oil refineries and retailers, which will feel the biggest hit in taxes.
And the idea won't be easy to sell to the American public, either. That is because in the end, these taxes will be borne by consumers as businesses that sell imported goods are certain to pass on at least some of their increased taxes to shoppers.
Publisher Steve Forbes, who twice ran to be the Republican presidential nominee and is an ardent critic of excessive taxation, argued in a full-page ad this week in the Wall Street Journal that the border tax could result in a 30-cent jump in gas prices and consumers paying 20% or more for everyday goods, much of which are imported from China and other low-wage countries.
Economists point out that such fears are overblown, however. Even as a border-adjustment tax raises the cost of imports, domestic demand for foreign goods will fall, thereby pushing up the value of the dollar. At the same time, as U.S. exporters pay fewer taxes, they will be able to lower their prices in foreign markets, which would drive up demand for dollars and also tend to lift up the dollar value relative to other currencies.
All in all, economic theory suggests that a stronger dollar would offset the additional cost to American importers and consumers.
However, Michael Gapen, chief U.S. economist at Barclays Bank, doubts that the exchange-rate adjustment would completely offset the higher costs. And neither he nor anyone else can say how quickly the dollar's value would rise.
What's more, some countries peg their currency values to the dollar, which would prevent an appreciation of the greenback, and international currency markets are notoriously unpredictable.
"Unless the dollar appreciates quickly and countries don't fix their exchange rates, at least in the short run you're going to be paying more for all that stuff," said Kimberly Clausing, an economics professor at Reed College who has written about the problems of the border-adjustment tax. "So that government revenue is coming in, but it's coming in on the backs of the people who shop at Wal-Mart and the Gap."
Because of such competing interests, business organizations like the Chamber of Commerce have been reluctant to take a position on the tax, foreshadowing the upcoming political battle in the halls of Congress and the White House.
"Most of the major groups want to remain mostly netural," said Scott Greenberg, an analyst at the Tax Foundation.
Toder, of the Tax Policy Center, agrees that shifting from the current system of corporate taxation to a destination-based tax on cash flow would make the U.S. a more desirable place for investment, to build factories or to conduct operations. The plan could even lead to higher wages, he said.
Still, he doesn’t think the proposal will fly, in part because of the preference to exporters, which also is expected to raise legal objections under the
Clausing and Reuven Avi-Yonah, a law professor at the University of Michigan, wrote in a paper this month that the wage-deduction element of the border-tax plan makes it incompatible with the WTO rules prohibiting export subsidies.
Berkeley economist Auerbach disputes the notion that the border-adjustment tax is an export subsidy: "Reducing taxes on wages does encourage domestic employment, but I don't see how that can be characterized as a trade-related policy," he said.
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