Congress is moving on tax “reform” and House committee hearings brought forth corporate executives to opine on a “border adjustment tax,” or BAT — one on imports, cast as part of a revised corporate income tax. This is House Speaker Paul Ryan’s pride baby that gets faint support from the White House.
The tax is a bad idea. But anything can happen in the current political situation, so let’s consider it.
First, how will the tax, as proposed, operate?
In a corporate income tax, businesses total up revenue and deduct allowable expenses. Inputs purchased by manufacturers or finished merchandise purchased by retailers count as expenses against revenue when calculating taxable income. That would change. Any items imported would not be deductible. The end effect is that of an import tariff equal to the marginal tax rate.
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This non-deductibility item would be paired with excluding revenue from export sales.
Second, if this works as a tax on imports, who will actually bear the cost of the tax?
Advocates of import taxes in general argue that such taxes hit the Mexican, Chinese or other foreign manufacturers selling things to us. Many supporters of a BAT say the same. This largely is incorrect.
Opponents, including retailers like Target and Walmart, assert that U.S. consumers would bear the entire burden of the tax and would face price hikes of 20 percent on everyday essentials — things like towels, toys, electronics, clothes, etc. This is based on the assumption that the new marginal corporate rate would be 20 percent and fully passed on to the consumer. This argument, putting it very politely, also is highly misinformed.
The proportion of a tax that buyers must bear depends on how sensitive to price changes quantities purchased are and on how quantities produced respond to the same price changes.
These vary between products and with the length of time to adjust. In a few cases, the price increase may be near zero and in others near 20 percent. No one really knows what the weighted average will be across myriad things we import.
In fairness to retailers, while the exact 20 percent figure is in error, consumers indeed will bear the largest burden. There is ample evidence from economic theory and history.
Note, however, that retailers make a logical error. They argue that the BAT will increase their tax burden greatly and that it will all be borne by consumers. But it can’t do both at the same time.
If buyers face 20 percent price increases, then retailers are not paying the tax themselves. If retailers really do pay more out of profits, then consumers are not paying more.
Also consider effects of a 20 percent tax on such imports as crude oil, coffee, cocoa, tea, shrimp, coconut, tin and chrome. Advocates focus on manufactured goods. Shuttered U.S. factories that once turned out such goods magically will reopen overnight and start cranking out substitutes at only a slightly higher cost to consumers than current imports. This is delusional. Many imports we never produced in the U.S. and many others could be made here only at much higher prices and after years of structural readjustment.
So it is not just an extra dollar per child’s jacket to send your child or a few dollars on a new set of dishes — all to support U.S. manufacturing. It is tens of added dollars per ton of potash fertilizer or tens of cents per gallon of diesel fuel for farmers and truckers. It is higher-cost steel for manufacturers, highways and high-rises.
Third, what about the effects of changes in the value of the dollar on who is affected by the tax and how?
Many economists pointed out that, considering all the likely effects of the BAT, the U.S. dollar would increase in value compared to other currencies. This increased buying power internationally would work contrary to the tax. Net effects on consumers would not be as large. This is correct in general terms.
Advocates have seized on this and make a having-the-cake-and-eating-it-too argument. A more expensive dollar will offset the tax and consumers won’t be hurt at all. Don’t fall for it.
First, no economist has argued that the adjustment will exactly equal the tax. Secondly, exchange values are driven by myriad factors, including interest rates, investment flows, national saving or dissaving and so forth. BAT advocates assume the economy will buzz right along with the new tax and that other nations won’t retaliate in any way. Such assumptions are dangerous.
Moreover, to the extent the dollar rises, it will offset all incentives to exports. And it would hit export sectors like agriculture just as a more expensive dollar always does.
An additional question is the legality of the proposed tax under treaties we have signed. The preponderant legal view is that a BAT would break World Trade Organization rules to which we have subscribed.
True, standing by contractual commitments to other nations isn’t a high priority to the Trump administration, nor to many Democrats either when trade-related. But every time we violate promises we made, we undermine our credibility as a nation. That has a cost, even if not immediately visible.
Finally, if we unilaterally break our side of these contracts, we can be sure two things will happen. Other nations will begin legal challenges. And other nations will take retaliatory measures of their own.
The period of 1929-1933 showed us the degree to which trade wars are first and foremost self-destructive. But once started, domestic politics in all affected nations are such that tit-for-tat is hard to avoid.
The border adjustment tax is a huge can of worms that we should leave sealed up.
St. Paul economist and writer Edward Lotterman can be reached at email@example.com.