It’s difficult to think of a time when US-Mexican relations have been this bad without either Pancho Villa or the Zimmermann Telegram making the news. And all it took was Donald Trump to hurl a few racial stereotypes, repeatedly make a promise he couldn’t keep, and then stomp his foot and shout “tariff!”
While the White House embarrassingly trotted out the threat of a tariff on Thursday, then trotted it right back in, that doesn’t mean the idea of skimming money from Mexican imports has disappeared. It’s just that Trump’s wall tariff will be hidden under the basket of awful the Republicans are pitching as the Border Adjustment Tax.
Kevin Brady, Chairman of the House Ways and Means Committee, and Paul Ryan, Speaker of the House, are looking to radically revamp the corporate tax system, with the goals of 1) encouraging corporations to stay in the U.S., 2) discouraging corporations from moving overseas in search of lower tax rates, and then selling products back to the U.S., and 3) raising additional tax revenue for the U.S. that can be used to lower the corporate tax rate, thereby avoiding increasing the deficit. What they came up with to accomplish all three is conveniently coined a "destination-based cash-flow tax with a border adjustment."
How does this wonder tax work? Well, it works like this—it’s a tariff, and it’s an export subsidy. It’s a flat sales tax, and a complete rewrite of the direct tax system. It may also be a floor polish and a dessert topping. Terrific, right?
Actually, there are a few problems. Such as: Who pays for this new wonder tax that generates revenue while making corporations smile?
That would be you.
The border adjustment tax isn’t a new idea. It’s been kicking around right wing think tanks for decades. At it’s core, the idea is to discourage imports and encourage exports. So, the simplest form could look something like this:
In the case of Mexico, the US imports $295 billion. Charge a 20% tariff, and you get $59 billion in revenue. But the US also exports $236 billion to Mexico, and US corporations worry that Mexico will just retaliate by matching the US tariff and cutting into their sales. Not a problem! If Mexico imposes a matching tariff, you subsidize those exports to the tune of $47 billion. Voila! American ag companies keep selling soybeans and you have $12 billion left over to build a wall. Repeat this with other nations, and you get revenues enough to gild that wall while cutting taxes for the top 1% to zero. It’s a miracle!
Only … no. There are some problems with that.
First off, it’s illegal as hell as far as the World Trade Organization is concerned. In fact, stomping on this sort of blatant market manipulation is exactly why there is a WTO.
Second, anyone can see what’s really happening here. This is a flat tax on consumption, paid by consumers, most of which goes to subsidizing corporate profits. Even Democrats could probably make this much clear to the public. Maybe.
So the Border Adjustment Tax can’t be just a tariff paired with a subsidy. It has to start with Paul Ryan’s wet dream — a complete Ayn Randian rewrite of the American tax system.
This new tax would move away from a direct income tax, and more towards an indirect "cash flow" tax. To do that, a corporation would be entitled to immediately deduct the cost of all asset purchases and inventory production or purchase costs. This would start to resemble a "value added tax," or VAT, which is common in many countries across the globe. A VAT attempts to tax consumption, rather than income, and that's what the new U.S. corporate tax would do ...
Consumption taxes are beloved of Republicans. Why? Because the more you make�—and here the “you” is both corporations and those unfortunate people who don’t happen to be corporations—the less they touch you. The more money in your pile, the less your income goes toward consumption.
Now then, having done away with direct taxation, there’s much more latitude for playing tricks at the border without incurring the wrath of the — hey, who’d have thought a giant international trade association would love flat taxes! — WTO.
Imagine you have three corporations, X, Y, and Z. Each corporation has the following specs:
[Company X] is a pure domestic corporation; all of its sales occur within the U.S., and all of its inventory comes from the U.S. Under the new tax system, X Co. would determine its tax base by reducing its $10M of revenue by its $4M of cost of goods sold and the $1M of asset acquisition costs and wages expense. Thus, X Co. would pay a 20% tax on $5M, for a total tax of $1M.
[Company Y] is an exporter, as the majority of its sales are to other countries. To provide incentive for companies to do just that, the new tax system would "adjust" Y Co.'s tax to account for the $8M of sales that leave our borders. This would be done by removing the $8M of export sales from the $10M revenue number, leaving Y Co. with only $2M of taxable sales. Y Co. would then further reduce the $2M by its $4M of cost of goods sold and $1M of asset costs and wages, resulting in a tax loss of ($3M), generating a nice little refund from the IRS, despite the fact that Y Co. was profitable to the tune of $5M. This would represent the huge advantage of being an exporter under this system: large, profitable multi-national corporations could find themselves in a loss position from a tax perspective.
Get that? With the “border adjustment,” exports are excluded from revenues. So, with the Border Adjustment Tax, corporations that export some portion of their sales see those exports written right out of their taxes. Win!
But hang on a sec. There’s still a few bugs in this perfect system.
First off, there’s a Company Z case.
[Company Z] is not an exporter; all of its sales are within the U.S. Unlike X Co., however, Z Co. purchases some of its inventory from other countries; thus, it is an importer. We don't want corporations doing so much importing anymore, so once again, the 20% tax will be adjusted when the imports cross the border. As a result, although Z Co. would normally be permitted to deduct the full cost of its $4M of inventory costs against its $10M of revenue, because $3M of that inventory was imported, Y Co. would not be allowed to deduct that $3M. As a result, Z Co. would pay a tax of 20% on $8M ($10M - $1M of domestic cost of goods sold - $1M of asset costs and wages), for a total tax of $1.6M.
Hmm. We’ve ended up in a position where Company Y pays less money in taxes because it exports goods, and Company Z pays more money in taxes because it imports goods. But the words “tariff” and “subsidy” are no longer used, and everyone is paying a WTO-favored VAT-style indirect tax in the first place.
So does this rather obvious shuffling of terms to get at the same results accomplish the goal of getting around WTO penalties? The answer is a big fat maybe.
The way the Republican proposal is drafted at the moment, wages for employees are still deductible. That’s something that is usually frowned on in a VAT tax.
… because we're so reluctant to fully embrace the VAT, and want to preserve the deduction for wages -- there is a chance the WTO would not permit a border adjustment feature, even on our version of the VAT.
Why does the US version include deductions for wages? To somewhat disguise the rather obvious fact that the connection between exports and jobs is not exactly 1:1. In fact, the massive incentive for exports provided here might also be thought of as an “automate or die” bill. If corporations couldn’t deduct incomes under this new scheme, that might be a smidge obvious.
There’s also an issue around how this whole thing plays out when it comes to the value of the dollar.
If you believe the economists, the border adjustment should have no net impact on the trade balance. While it might seem like Y Co. came out way ahead in our examples, you have to remember that if the value of the dollar truly increases as expected, the $10M of revenue Y Co. earned from overseas will suddenly not be worth nearly as much as it once was.
Get that? For all the huff and puff involved, imposing the Border Adjustment Tax leads to no change in the trade imbalance. Instead it fuels a continuing increase in the value of the dollar relative to other currencies. Does this in turn toss off an inflationary spiral? A retreat of foreign investment? An outpouring of fat US bucks looking for cheaper investments overseas? Dunno. Dunno. Dunno.
Finally, there’s the little matter of who pays for all this.
If we have a bunch of Corporation Ys up there enjoying a big tax break from exports, and few Corporation Zs paying penalties for imports, then the whole thing actually brings in less revenue than current taxes. But at the moment there are a lot more Corporation Zs making imports than Corporation Ys selling exports.
So, in theory, maybe, the new structure actually brings in more revenue by doing what our very simple example way back there at the beginning did in the first place — punishing imports and rewarding exports. This is a fact obvious enough than when Donald Trump was first walked through this proposal, his response was to just go with the tariff / subsidy solution, because it was all the same thing except “too complicated.”
Anyway, let’s assume Paul Ryan did the math correctly and the tax generates some net revenue. Which is cool, because the Republicans have a place to spend that money. They want to use it to 1) offset other tax cuts they want to make and 2) pay for that wall!
But ... there’s something still missing here. Who pays for that extra cost that corporations are incurring? After all, that cost isn’t in shrunken down pesos or rubles, but puffy new supersized dollars. It has to come from somewhere.
Oh, that’s still you.
If you've learned nothing else from the examples above, hopefully you realized that X Co., Y Co., and Z Co. are all U.S. corporations. Thus, it is not Mexico that would pay the import tax, it would be the U.S. corporation that imports the product, or Z Co. in our example. And as we stated above, if Z Co. has to pay an extra 20% to import refreshing Dos Equis, who do you think is going to bear the cost of that 20% increase? You, the beer-swilling consumer.