Washington Insider: Border Adjustment Proposal

There has been a flurry of tough battles and numerous proposals for reforms, great and small, as Congress rushed to leave town for the year. Amid all this, Bloomberg says, is the House Republican proposal to tax imports and give exporters a deduction for products they send overseas. And, now the key question being raised by economists and tax policy watchers is whether this "border adjustability" provision will make it into the final draft of legislation to overhaul the tax code.The idea is fairly new and certainly different, but needs to be understood as much as possible because it is a serious proposal and a central element of the Republican tax plan. It is seen as a barrier to prevent U.S. companies from shifting profits overseas, it also offsets the cost of corporate tax rate proposals.Still, as you might imagine, retailers, led by the Retail Industry Leaders Association and Koch Industries Inc. hate the idea and have publicly denounced it as a threat to consumers through higher prices and reduced corporate profits. This has prompted a team of economists at Goldman Sachs & Co. to say that lawmakers will seek an alternate route."In light of the uncertainty regarding the potential effects of such a policy, and the opposition it has already provoked, we think that Congress is more likely to move away from the destination-basis tax proposal," the Goldman economists said recently.However, the border adjustability provision is seen to be at the center of Republican tax proposals and "all the other features—full business expensing, lower corporate rates and individual income rate reductions—stem from that" a Republican aide told Bloomberg. Without it, the plan doesn't work, he said.Previous plans for a tax revamp have included strong anti-base erosion rules, such as a minimum tax on foreign profits, rather than the import tax-export deduction approach, but those were extremely unpopular, Douglas Holtz-Eakin, president of the American Action Forum, said."It's important to not pretend that it's this or nothing," said Holtz-Eakin, who supports border adjustability. "You're going to need something to protect the tax base. Pick among realistic alternatives."Advocates for border adjustability say that the dollar will appreciate to compensate for the additional tax that importers will pay to bring products into the country. The Goldman economists said they are skeptical that the transition, which would require the dollar to appreciate 25 percent under the GOP plan, would go smoothly. In addition, it is unclear how the dollar appreciation would affect competition of U.S. products overseas."Such an abrupt change would result in large negative wealth effects for U.S. residents and the risk of potentially serious dollar-denominated debt problems abroad," the Goldman report said.It is also unclear if the tax would comply with World Trade Organization rules, which permit border adjustments in systems with value-added taxes, but not for income taxes. The House Republican plan is a hybrid of the two.There is a "significant danger" that it would be understood as a tariff, which could lead to litigation with the WTO, Joel Trachtman, an international law professor at Tufts University told Bloomberg. The process to resolve the case could take years, and the US could continue to impose the import tax while the case went through the WTO panel and appeal process.Despite opposition to the border adjustability plan, Henrietta Treyz, an analyst with financial research firm Height Analytics LLC, still pegs the likelihood of the border adjustability provisions making it into a tax overhaul bill at 60 percent.One way that some of the opposition could be reduced is to include import tax exceptions for certain goods, such as oil, or for products under a certain dollar amount, which would appeal to apparel importers, Treyz said. Small carve-outs to appease certain industries could quell some of the outcry without detracting too much from the approximately $1 trillion the border adjustments are projected to raise over a decade, she said.House Ways and Means Committee Chairman Kevin Brady, R-Texas, said he is looking at issues related to carve-outs for raw materials, such as oil, while he continues to get feedback from business groups about how to build a tax system that will expand the economy."The nature of tax reform is to radically change the tax code so as to simplify, lower the rates, broaden the base and, in this case, foster economic growth," Holtz-Eakin said. "Those big changes inevitably have winners and losers. The losers are never mollified and often very loud and by the end usually quite hoarse. That's just the nature of the beast."At the same time the import tax proposal is considered, it will need to be explained and examined much more fully than it has been to date, especially regarding how the impacts of dollar appreciation on exports would evolve; how it might be possible to explain the tax benefits for exports in a way that avoids tagging them as prohibited export subsidies; as well as how "carve outs" for commodity markets could be fairly allocated, a process that producers should watch closely as it proceeds, Washington Insider believes.