Everything You Need to Know about the Border Adjustment Tax (BAT)

The new Administration and the Republican Congress are getting serious about tax reform.  Just this week, Republican lawmakers commenced meetings to determine the path forward.

The tax code has not been updated since 1986(!), so there is consensus that changes are long overdue.  In fact, the United States has the highest corporate tax rate in the world. However, there is very little consensus about what reform might look like.  As discussions get underway in earnest, one proposal, the Border Adjustment Tax (BAT), has garnered the most attention.

Heated discussion surrounds Paul Ryan’s Border-Adjustment Tax (BAT) bill proposal, and if it comes to life, it may be an avenue for these reforms.  What is BAT, what is the Value-Added Tax (VAT) that inspired it, and how do they differ?  What would BAT do to U.S. trade and more specifically, Washington trade?

Border Adjustment Tax? What is it and what do I need to know?

Simply put, BAT would levy 20% on imports, while making American companies’ export-revenue tax exempt or deductible.  Imports could no longer be deducted as costs, and the taxable profits would be the total domestic sales minus the domestic costs.  As method of tax reform, BAT is much simpler than our current intentionally labyrinthine corporate tax laws, and should make corporations incentivized to seek elaborate ‘tax advantage’.

At its core, VAT is a consumption tax levied on the consumer for the value added at each step of production, based on the type of good and where it is purchased.  In some cases, it replaces other consumer taxes like sales tax. Ideally, the VAT paid for goods and services used in a business’ production process is balanced out by the VAT collected when consumers buy the product. The government can help maintain this balance with tax refunds or similar methods.

BAT would function nearly identically to VAT, but would be directly taxed, and focus on imports and exports, whereas VAT is levied against all transactions and thus does have a specific effect on trade.

The Good, the BAT, and the Ugly

Any policy change will be a trade-off, with some winners and some losers. BAT is no exception. In fact, BAT is surrounded by particularly charged dialogue from businesses that will be affected differently, including importers, small-operation exporters, and exporters with large, expensive products. Even with the help of economic models, it’s difficult to predict how this policy would affect U.S. trade relationships with other countries as well as the value of our own currency. WCIT hopes to take you on a neutral walk through the benefits and pitfalls so you can make informed decisions for your business.

Positives: There are many potential benefits to BAT.  Under the current system, the U.S. is the only member of the OECD to not employ a VAT, so U.S. companies pay sales tax when first purchasing a product and then pay VAT when they export.  This incentivizes businesses to relocate to other countries to avoid the more expensive VATs, sales tax.  BAT would level the playing field in this sense, encouraging businesses to bring manufacturing back to the U.S. and export abroad, or buy American, sell elsewhere.

It also encourages American consumers to buy U.S.-made by increasing the cost of imported goods.   This leveled playing field could see prices decrease or wages increase as more products are manufactured and sold in the America.  Less USD in global circulation should also increase the purchasing power of the greenback, as foreigners will need more of their currencies to purchase American goods, and Americans will need to spend less to purchase foreign goods.  This, in turn, should provide some protection against the price changes that will likely hit consumers and retailers the hardest.

BAT is also likely to increase federal revenue by broadening the tax base. Because the U.S. imports far more than it exports, changing from a system of taxing exports to taxing spending on imports could provide as much as $1 trillion over the next decade.

Negatives: That said – there are risks to BAT as well. Many Washington businesses, including major retailers, fear BAT’s consequences. Local companies that depend upon imported product would be faced with staggering costs that could prove difficult to work around. Essentially, some importers argue that a BAT would make their products less competitive. If a t-shirt must increase in price by 20% to make up for the tax, U.S. consumers may look to other brands for cheaper alternatives.

Second, there are no guarantees that the wages or purchasing power of most Americans will increase, and if these factors do not increase then low-income families will be hit the hardest.  Retailers will also take a hit, as they tend to import in great quantities, and these costs will likely be passed directly onto the consumers.  Consumers forced to pay more for necessities will end up buying less, which could further damage our economy.

If the dollar does appreciate by the needed 25% to compensate for the 20% BAT, it will create a slew of global issues.  Currencies tied to USD, economies with debts in USD (like many developing countries), and economies reliant on U.S. consumers (like China) could experience rapid destabilization. Alternatively, larger trade partners could rise to the occasion and undo the potential competitive benefits, or simply find alternatives to expensive U.S. products. If wages and prices rose instead of the dollar, the Federal Reserve would have to hastily devise and enact a plan to stop unprecedented inflation.

Ultimately, the most perilous risk of BAT is the possibility of sparking a trade war. Other countries could levy taxes or tariffs against the U.S. as retribution.  These retaliatory measures are likely against World Trade Organization (WTO) laws – but BAT is as well.  The WTO prohibits direct income taxes from being border adjusted.  Since BAT is classified as a direct corporate income tax, it will likely face stiff opposition from our global partners and risks the U.S. position in the WTO.


BAT and Washington

BAT is a trade-off: with great reward comes great risk.  Some large manufacturers stand to benefit greatly from BAT, as they export valuable goods requiring skilled labor, which should increase economic prosperity across Washington.  Additionally, Washington’s coastal locale and world-class ports allow for major exporting. In Washington, we generally stand to see greater benefits than landlocked states.

On the other hand, American importers and retailers (97% of which of which are small business with less than 500 employees) risk being hit hard by BAT.  Rising costs and the inability to shield customers from them means that small to medium-size businesses would have a tough time competing.  If the Pacific economies that consume American products exported from Washington are hit too hard by the stronger dollar, or find alternatives to Washington products, our local communities could be in for a lot of pain.

By Jon Okun

Ashley Dutta
ashleyd@wcit.org
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