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Prospects: Tax Reform and the Border Tax Adjustment
- Corporate tax reform is an important priority of both the president and Congress. Both support a system that would offer much lower tax rates in exchange for closing loopholes, such as the deduction of interest payments.
- Congress wants to go a step further and change the current corporate tax on income from production in the U.S. to a tax on income from sales in the U.S., using a border tax adjustment (BTA). The BTA would exempt income from exports but tax the value of their imports. It would operate like a VAT.
- Proponents of reform argue that the BTA would level the playing field, removing incentives for companies to relocate overseas, reducing the gaming of the current complex system, and leading to significant repatriation of income held abroad.
- However, unless there were offsetting changes from dollar appreciation, the BTA would provide tax benefits to exports and tax penalties on imports. The proposed 20% tax rate (down from the current 35%) would require the dollar to rise 25% to be fully offsetting, according to most estimates. And many, including the president, think the dollar is already “too strong.” A dollar increase of that magnitude could be globally destabilizing, even though holders of dollar assets (such as China) could benefit.
- Without offsetting dollar depreciation, exporters like GE would win and importers like Walmart and oil refiners would lose. The smaller the ultimate currency increase, the more the BTA acts like a tariff, something the White House seems keen on using at least as a negotiating ploy. This rebalancing of production to the U.S. could be quite inflationary, particularly with the U.S. close to most measures of full employment.
- Given the existence of globally integrated supply chains, implementing the BTA may prove a nightmare and quite disruptive. Even a modified BTA may be ruled illegal by the WTO, adding to the uncertainty. Business may conclude that the BTA is not worth it and accept a smaller cut in the corporate tax cut to something closer to 25% as a fair trade for closing some tax loopholes.