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US Border Adjustment Tax

  • Mar 12, 2017 | Richard Asquith

US Border Adjustment Tax

Following the election of President Trump at the end of 2016, a standing Republican proposal for a Border Adjustment Tax (BAT) corporate tax has been gaining momentum.

BAT - or more correctly Destination-Based Cash Flow Tax ('DBCFT') - would differ significantly from a simple border tariff, which had been proposed during the elections, or a Value Added Tax.  The aim of the fiscal measure would be to boost US production and jobs through an export tax exemption, and penalise imports via a tariff.  It would potentially also unlock a much-needed reform of the antiquated US tax regime.  This could encourage US multinationals to repatriate billions in offshore profits, and deter tax avoiding inversions.  This massive expansion in the US tax base could then fund major investment programmes in the creaking US infrastructure.

However, there are concerns about the proposed tax reform.  The success of the DBCFT proposal hinges on a major dollar currency increase calculation to balance the import levy.  This could lead to sharp rises in prices in US shops, which may affect the poorest hardest. DBCFT risks retaliation from other countries which may view it as an illegal tariff and trade subsidy.   The triggering of a sharp dollar appreciation may also threaten to destabilise emerging-market countries with large dollar-denominated debts that could be vulnerable to defaults.

How DBCFT would work

The proposed DBCFT has two key components:

  1. Import tariff: this is the BAT element of DBCFT.  It would put a non-recoverable levy on imports – between 10% and 20% has been mentioned by its backers. The cost of imports would no longer be deductible against profits for corporate income tax calculation purposes.
  2. Export tax exemption: exports of goods from the US would be excluded from companies’ corporate income tax calculations, thus making them exempt.  Only sales of goods, minus US production and payroll costs, would be subject to corporate income taxes.

The outcome would be to make importing more expensive, and boost exports through a tax subsidy - although they may be subject to tax/VAT in the country of destination.

$1 trillion winners and losers

The principle winners would be companies with large, US-based production operations.  They would become more price-competitive compared to rivals whose products were fully or even partially imported.  This will likely encourage all companies to invest in US production and job creation.

The DBCFT would likely provide an immediate boost to US fiscal revenues from the import charge.  The Tax Foundation has estimated DBCFT could raise $1 trillion over ten years.  This could fund much-required infrastructure investment.

The principle losers would be companies that import goods from China and the rest of the world.  This could impact US retailers, who contend that there will be a sharp rise in consumer prices in shops on cheap imports of clothing and household goods.  It could also impact importers who rely on specialist foreign suppliers of equipment or commodities unavailable in the US.  The countries operating trade surpluses with the US, including China, Japan and Germany, would lose tax revenues from the change as their companies sold less to the US.  This may force them to raise their own taxes and/or retaliate (see below).

Critics claim that the rise in retail importer prices will fall disproportionately on the poorest US consumers who tend to purchase more low-cost imports as a proportion of their income. Supporters of DBCFT counter that this will be cancelled out from the benefits in increased employment opportunities and linked rises in salaries.

The difficulty for DBCFT advocates is showing that the boost to domestic production, job creation and exports rise will more than cancel out the surge in importer and (therefore) consumer prices.

Is it a VAT?

The DBCFT has been compared to Value Added Tax.  This is not correct: whilst importers into VAT countries suffer an import VAT charge, this is fully recoverable unlike the import levy on BAT.

However, DBCFT can be compared to VAT in that – in theory – they are both neutral to international trade. DBCFT, like VAT, also shifts the balance of government fiscal revenues away from corporate income tax which, it is believed, are a restraint on economic growth, and is outdated for a globalised world.

Neutral impact on world trade – the $ bet

It is asserted that DBCFT is neutral for international trade. US exports would be cheaper but the extra demand will lead to an appreciate of the US dollar.  This would then cancel out the export subsidy as US products sold overseas would become more expensive to foreign buyers. It should also neutralise for importers the import levy as the higher-valued dollar would make foreign purchases cheaper.  Hence no long-term impact in world trade if the currency appreciates as predicted.

Economists are divided on this currency rise hypothesis. It is a gamble to rely on a large currency rise to harness fiscal measures as there are so many other factors determining a floating currency’s performance.  Globally, considerable trade and debt not involving US parties is priced in dollar as the world’s reserve currency.  The ability to adjust prices on these global arrangements following currency changes may take many years to work through.

For emerging economies, with large stocks of dollar-denominated debt, there is a major risk of defaulting on a massive scale as their capital and interest charges rise following a dollar appreciation.

Unlocking US corporate tax reform

US corporate income tax has remained largely unreformed in over 30 years, and includes the world’s highest headline tax rate at almost 40%.  The promoters of DBCFT claim it could unlock a major reform of corporate tax, and help US companies.  It could facilitate a 20% US corporate tax rate.

DBCFT's exemption of exports from corporate tax means a switch for US corporate tax from an origin basis (tax where made) to a destination basis (tax where consumed). US companies would only be taxed on sales of goods produced and sold in the US.  They would be able to deduct US payroll and production costs from their US sales.

Such a destination-based cash flow tax would also encourage US multi-nationals with complex offshore tax structures to bring back to the US intellectual property rights to benefit from the promised reduced in corporate income tax rate.  This end to ‘profits shifting’ in turn could help unlock a much-needed overhaul of the arcane US corporate tax regime.

Uncertain reaction from global trade partners

Many countries with large trade surpluses with the US (e.g. Germany and China) view the import levy element of DBCFT as penalising their exporters.  It is likely that such a tax would draw retaliatory tariffs and sanctions.  There are likely to be long appeals to the World Trade Organisation (WTO) which overseas international trade and tariff disputes.  Countries may make the case that the tax is an unlawful subsidy on domestic goods, a tariff on imports and an export subsidy via the deduction of US-only payroll costs.  Given the potential sums involved, any cases would likely be expedited through the WTO.

Opponents of DBCFT claim it could spark similar a retaliation to the 1930s Smoot-Hawley Tariff Act, which was a causative feature to the global depression of the time.

A fiscal role of the dice worth taking?

Supporters of the DBCFT have put forward complex justifications for the new tax, saying it could boost the US economy and unlock the stubborn problem of US corporate tax reform which has left US companies severely uncompetitive globally.  But, for it to work as proposed, a major appreciation of the $ of around 25% would be required if the discussed 20% import levy is implemented.  This would have a drastic impact on countries with $-based debt.

The challenge over the forthcoming months for DBCFT supporters is demonstrating if the benefits to the US justify the complex risks to global trade required to be taken.

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VP Global Indirect Tax
Richard Asquith
VP Global Indirect Tax Richard Asquith
Richard Asquith is VP Global Indirect Tax at Avalara, helping businesses understand their compliance obligations as they grow globally. He is part of the European leadership team which won International Tax Review's 2020 Tax Technology Firm of the Year. Richard trained as an accountant with KPMG in the UK, and went on to work in Hungary, Russia and France with EY.