Is Border Adjustment Another Term for VAT? To Tax or Not to Tax… and Where?

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We haven’t heard much of late about President Donald Trump’s border adjustment tax, but that doesn’t mean to say it has gone away.

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Indeed, the fact that it has a measure of support in the Republican Party suggests it could be on the agenda in the not-too-distant future. The idea is to transform the corporate tax landscape from a system that has prevailed for nearly 100 years, in which profits are taxed at the place of production, to a system in which profits are taxed at the place of sale.

A-destination based cash flow tax (DBCFT), as proposed by the House Republican tax plan, would include border adjustments that exempt exports but include imports in tax bills rather than raising federal income from a corporate income tax. As William Gale, a senior fellow in Economic Studies at the Brookings Institution explained in a recent article, all advanced countries except the U.S. already have a form of value-added tax (VAT), generally levied on top of corporate income taxes. All of those VAT systems are border adjusted, such that goods that are imported are taxed and those that are exported are not.

BAT or VAT

As part of the president’s pledge to bring jobs back to America, the border tax could have much to commend it. For example, if the U.S. introduces the system unilaterally, a factory in Ohio will pay no tax on the goods it exports to the E.U. while a factory in the E.U. will pay the border tax on its exports to the U.S. If you are a multinational corporation, suddenly it makes a ton more sense to have your new factory based in Ohio rather than some “lower cost” location.

Gale suggests that the border adjustment tax in the house Republican plan is probably not World Trade Organization compatible. The WTO requires that imports and domestically produced goods are treated the same. But, as the article explains ,the DBCFT taxes the whole value of imports while only taxing the part of domestically produced goods that relates to above-normal returns to capital owners. This could be addressed by replacing the DBCFT with a value-added tax which would comply with WTO rules.

One objection to the border attacks is that exchange rates would immediately adjust to compensate to the full extent of the tax. The theory goes that the dollar would rise in value as foreigners need more dollars to purchase exported U.S. goods, while importers need less dollars to buy the reduced quantity of imports. This may prove in practice to be too simplistic a model. The amount of foreign exchange related to trade flows is dwarfed by the amount related to asset purchases and sales.

Prices or Employment?

If the exchange rate does not adjust fully, the effect of the border adjustment tax could be to encourage exports to rise and imports to fall which would reduce the trade deficit. Consumer prices would rise due to higher import costs, which incidentally would likely hit low-income households disproportionately, but should — over time — encourage the relocation of jobs back to the U.S., thus creating employment opportunities. Gale identifies importers, particularly, in apparel, oil and retailing that would be hit hard, but on the plus side there would be less wealth transfer from Americans to foreigners.

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The House Republican tax plan was met with skepticism in many quarters, but in a world of multinational corporations and one increasingly focused on the threats arising from globalization, a border adjustment tax, judiciously implemented, may actually have a lot to commend it. The impact on importers, exporters and manufacturers would, however, be profound and the topic deserves our continued attention as the debate evolves.

Comments (2)

  1. VATfan says:

    Shifting federal taxes from income to consumption (VAT) would grow the economy and jobs. All our trading partners currently use VAT’s to the competitive disadvantage of the US. Shifting to VAT would only harmonize our tax system with the rest of the world (over 165 countries use VAT’s), and would not stimulate a trade war.

    VAT eliminates the burden of government from the price/value relationships of goods crossing borders. The tax is added equally to imports and domestic production, and is subtracted from exports.

    1. Jeff Yoders says:

      Good point, VATfan, but it would also apply to ALL TRANSACTIONS and not just exports and imports by corporations. I believe the reasoning behind the “border adjustment tax” is that it treats imports/exports by businesses separately than transactions by individuals buying single items abroad or simply sending Christmas gifts to relatives in other countries via Amazon or some other global shopping platform.

      Jeff Yoders,
      Editor

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