Over the past few weeks, I’ve had numerous clients ask me about how they might be impacted by the border adjustment tax. In fact, so many have expressed concern that they’re already seeking advice on how to avoid being impacted, even though nothing has been enacted into law. For those of you whom are unfamiliar with the subject, the border adjustment tax is currently a proposal, not law. The idea is derived from the House Republican’s Ways and Means Committee tax reform blueprint, “A Better Way”.[i] One of the central themes in the House GOP blueprint is to shift the taxation of goods and services from a “worldwide” to a “territorial” based system. Proponents of the plan believe that it would dramatically improve U.S. competitiveness because companies would no longer be forced to keep cash trapped overseas for fear of those funds being taxed upon repatriation. In other words, under a territorial system all earnings from overseas would be exempt from tax.
Sounds simple enough, but my job as a tax practitioner is to delve further into the details by looking for a “catch”. Under the GOP proposal, exporters would be exempt from tax, meanwhile importers would be subject to a border adjustment. A border adjustment is synonymous with a “value added tax” or VAT. As a matter of fact, most countries around the world have a VAT except for the United States. The U.S. does have something similar, a sales and use tax, but it is for the most part levied at the state level.
The purpose of a “border adjustment” is to place both foreign and domestic producers on a level playing field. The intended effect is to create a disincentive for producing goods and services overseas by virtue of taxing all imports. In my opinion, tax policy alone will not bring manufacturing back to the U.S. The primary reason companies produce so many of their goods overseas, is due to labor costs. For instance, in the case of Carrier who was planning on moving production from Indiana to Monterrey, Mexico; workers in Indiana were earning roughly $25 per hour compared to $3 per hour in Mexico. Everyone knows that American companies cannot compete against such cheap labor rates. That is why we have seen so many industries here at home disappear over the past three decades.
Despite that, most people absolutely incensed about the border adjustment tax is the fear of a sharp spike in the price of products they are accustomed to buying. Most everyone you speak with knows that Apple is not going to be manufacturing iPhones in the U.S. anytime soon. As a result, everyone involved in Apple’s supply chain from parts suppliers, to contract manufacturers, to retailers will be forced to pass along any “border adjustments” onto consumers. This is causing tremendous angst amongst retailers because any precipitous spike in prices would be extremely catastrophic to the spending power of low and middle-income consumers. It literally could mean the difference between families being able to buy a new TV versus shopping for basic necessities. That is why so many business people I speak with are just freaked out because over two thirds of our nation’s economic activity depends upon consumer spending. Likewise, most people remember not too long ago how quickly consumer spending changed when gasoline soared from $3 to over $4 per gallon.
Proponents of the plan believe that any such price increases would be offset by a rising dollar. However, in my humble opinion that is a very risky proposition. Currency rates are dictated by a variety of factors including but not limited to the trajectory of interest rates, inflation, and capital inflows versus outflows. This policy assumes that interest rates will remain perpetually low, which is highly unrealistic given the recent pronouncements from the Federal Reserve. Furthermore, it assumes that the U.S. will remain an attractive destination for investment. However, there are serious concerns about the appetite for foreign investment in the U.S. given the protectionist rhetoric coming from the Trump administration as of late.
Moreover, for those of you involved with multi-state tax compliance, a border adjustment tax would not replace the existing sales and use tax levied by most states. Too many states rely heavily upon raising its needed revenues from their state’s sales and use tax. Businesses already incur a tremendous burden complying with each state and locality’s sales tax. Now, they would be forced to comply with the onerous record keeping requirements of a federal VAT?
And finally, serious concerns have been raised by many prominent lawyers about whether a “destination based cash flow tax” would violate WTO rules. They surmise that a border adjustment tax works as a “de facto” tariff. Article 3 of the General Agreement on Tariffs and Trade, prohibits a nation from favoring a domestic item over an internal item through the use of internal taxes.[ii] It should also be noted that no major economy in the G20 has ever adopted a cash flow tax. So, from what we know thus far about the border adjustment tax, there are still more questions than answers.
Stay tuned for any updates.
[ii] Checkpoint Contents. International Tax Library. International Tax News. International Taxes Weekly Newsletter. Volume 8, No. 6 February 7, 2017. “U.S. tax plan would break WTO rules, lawyers say, as EU business frets”.