With all the political intrigue and in-fighting happening in Washington, D.C., one piece of the House Republican tax blueprint that has split the party into two camps may have slipped under most readers’ radars: the proposed border adjustment tax (BAT) on imports.
The BAT, which would impose a 20 percent tax on imports as a replacement for the current corporate income tax, has the support of House Speaker Paul Ryan and other Republicans, but is opposed by others in the party as well as several major, import-heavy industries – including automotive manufacturers, dealers and parts suppliers. As of mid-June, the Trump administration’s tax reform proposal did not include a BAT.
The BAT was the subject of a recent roundtable sponsored by the Motor Equipment Manufacturers Association (MEMA), with economists and industry representatives sparring over the actual effect this destination-based cash flow tax would have.
Under the House proposal, the current corporate income tax would be abolished to incentivize companies to return overseas profits to the U.S. to be reinvested. The BAT would impose a 20 percent tax on all imported goods. Exports would be exempt from taxation. The House also wants to eliminate corporate interest deductibility.
That poses a big problem for importers, says Xavier Muscgat, senior partner and managing director of the Detroit office of Boston Consulting Group. Muscgat noted that international trade in the vehicle industry is relatively balanced. The company examined the potential impact of the BAT on auto parts and vehicles, and found that it would increase costs for consumers without encouraging companies to begin manufacturing more parts or vehicles in the U.S.
“The U.S. market is at peak capacity,” Muscgat said. “The only way this plan would repatriate jobs is if manufacturers shift capacity from one plant to another, and in the U.S. OEM capacity is at 100 percent utilization. They don’t have the space to create new jobs at those plants. They would have to build new plants,” which is unlikely given the cost.
According to Muscgat’s figures, the BAT would add as much as $4,000 to the cost of some vehicles, and the average cost of a car in the U.S. would increase by $1,800 across all manufacturers. Because only domestic products would be deductible as a cost of goods sold, retail operations would also face higher tax bills.
“That’ a significant tax that would be paid by consumers,” Muscgat said. And although that increase wouldn’t dramatically reduce the number of cars sold, consumers would begin “decontenting” cars by purchasing few features and accessories. Boston Consulting estimates there would be an 8 percent decrease in add-on features, resulting in a loss of 35,000 to 70,000 jobs in the supplier base.
The argument in favor of the BAT is that both corporations and consumers (under the proposal) would be paying lower taxes, and the BAT would positively affect the exchange rate so that the dollar would appreciate.
The BAT is different than a traditional value-added tax (VAT,) which is the approach taken in many other countries, in that it allows deductions for wages (which traditional VATs do not). It is a consumption tax, so all goods consumed in the U.S. would be taxed at the same rate, regardless of where they were produced.
“The cleanest thing to do would be a pure VAT system, but the problem is that’s a political non-starter for Republicans,” said Warren Maruyama, partner at Hogan Lovells and former general counsel for the U.S. Trade Representative. That’s because many Republicans are opposed to any plan that creates new tax revenue streams.
The idea is that the BAT would cause a large appreciation of the dollar, such that the negative affect on imports would be nullified. However, if the dollar doesn’t appreciate significantly, then prices would rise (as would, theoretically, wages). However, that still means that both manufacturers and consumers would pay higher prices. If the anticipated currency adjustment does not happen as quickly as hoped or isn’t as high as required, the BAT could cause significant economic disruption.
“If you are really exposed, this will be incredibly disruptive,” said Chad Brown, senior fellow at the Peterson Institute for International Economics. “We’ve looked at other countries that have implemented value-added tax regimes to see how long and to what channels these changes happen. [Currencies] do tend to move over time, but it’s not immediate. No country has ever done the sort of big change we are proposing here.”
“This is a new tax that is going to be passed on to the consumer,” said Cody Lusk, president of the American International Automobile Dealers Association. “It would be a significant cost and we have real concerns about that.”
Another problem is that the BAT may not pass muster with the World Trade Organization.
“The WTO does allow border tax adjustments, but they are limited to indirect taxes like a VAT or sales tax,” Maruyama said. “This is not a true VAT. If you parse it, it’s an effort to cram border adjustability into corporate income tax reform. That does not work under WTO rules. There would be challenges in the WTO to this as an illegal export subsidy, and we could find ourselves facing a humungous retaliation bill.”
Export-heavy industries favor the BAT, and have formed a lobbying group called the American Made Coalition. Brian Reardon, an advisor to the group and a former special assistant for economic policy and staff member of the National Economic Council under President George W. Bush also was on the panel.
“What they are imposing is a cash flow tax. It’s like a VAT, only better,” Reardon said. “There’s a deduction for labor, so you don’t double tax labor.”
Reardon argued that the BAT would make it easier to export cars from the U.S. to countries like Germany and Japan. Other panelists pointed out that taxes were only a small part of why those countries don’t import from the U.S.
“And we’re operating at capacity here, so I don’t know where all those exported cars would come from,” Cody added.
“The BAT will increase the price of American vehicles across the line … at a time when affordability is a huge issue here,” Cody added. “This is not a tax cut, it’s a brand new tax that shifts the burden from U.S. corporations who will pay no net tax under this, and gets shifted onto consumers, who will have everything they buy cost them more.”
Exactly how the BAT will play out, if adopted, is unclear because no other country has adopted an identical policy. The expected currency adjustment, for example, could take several years – which could be fatal for particularly price-sensitive importers in some industries.
According to Gordon Gray, director of fiscal policy with the American Action Forum, the debate has been muddied somewhat because the effect of the BAT will happen in concert with other portions of the House blueprint. “If you take the border adjustment in isolation, all else being equal, you will have an offset in currency appreciation,” he said. “You plow that into the blueprint, and you have incentives going in different ways that will move the dollar to some degree. We just don’t know what way that is right now.”
Even if the BAT passes through the House despite some Republican opposition (like the healthcare bill), it may be dead-on-arrival in the Senate, and President Trump’s position appears to be anti-BAT.
“I’m not the smartest guy in the room, but I can do math,” Lusk said. “I haven’t heard one senator come out and say this is a great idea.”
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