Insurance For The Border–Adjustment Tax

Guest Post Written By: Stuart Leblang and Amy S. Elliott

Tax lawyers, Mr. Leblang was associate international tax counsel for the Treasury Department, and Ms. Elliott a writer for Tax Analysts.

Disclosure:  Some clients of the attorneys who authored this piece could stand to benefit from this change in the tax code.  However, other clients of the attorneys could be harmed.

Major retailers are waging an intense campaign against the border adjustment tax (BAT), claiming it will raise the prices of essential consumer goods, increase the cost of gasoline and cause businesses with high import costs to cut jobs.  Congress can design insurance to largely eliminate these risks.

Importers (and indirectly consumers) fear the dollar will not sufficiently appreciate to offset the impact of what amounts to a tax on imports and a subsidy for exports.  They are so focused on the currency point that they are forgetting a critical benefit of the plan:  It will force businesses that had been shifting their profits to low­tax jurisdictions to finally pay their fair share.  If importers can be protected from currency uncertainties by way of an alternative tax, they may come to support a reform plan that promises lower rates than what they will get under traditional tax reform.

The alternative tax would give businesses most at­risk under the BAT (those with relatively high import costs) the ability to be taxed similar to current law.  They would be allowed to deduct most of their import costs, just like today, and they would be subject to a relatively high rate of tax, just like today.

Because their taxes wouldn’t generally go up, they would have no need to increase their prices.  Consumers would be protected.

The catch is that the alternative tax is designed so that, as a business’ import costs decline, the BAT starts looking more and more appealing.  Import costs could decline because the currency is adjusting—at whatever time and for whatever reason that happens—or because the business has had a chance to rearrange its supply chains to rely less on imports.

Watch On Forbes:  IRS Phone Scams Still Affecting Taxpayers

The benefit of the alternative tax will be capped at a business’ historic after­tax U.S. operating profit margin.  As its import costs decline, the value of the alternative tax’s import deduction also declines.  At some point the import costs will be low enough that it makes more sense for the business to be taxed under the BAT, which offers a much lower tax rate of 20% and no limit on profit margin.

The alternative tax is designed to preserve one of the most appealing features of the BAT:  its ability to curtail corporate tax dodging by multinationals.  All import costs from third parties will be deductible under the alternative tax.  But when it comes to related­party import costs, they are only deductible if they are traceable to real expenditures as opposed to pure profit.  No more inflating prices to avoid U.S. taxes.

The alternative tax isn’t simple or perfect.  It is an insurance policy that will enable consumers, retailers and other skeptics to get behind tax reform that has a real chance of growing our economy.  The alternative tax preserves the incentive for currency adjustment.  In fact, if the currency adjusts overnight to perfectly offset the BAT, the alternative tax will be irrelevant.  It is a tool to generate political support.

The number of BAT bashers seems to be growing by the day.  But they should carefully consider the options.  1986­style reform will not solve our tax code’s many problems.  Under the alternative tax, some importers only need the dollar to appreciate 8% before they would have higher after­tax profits under the BAT—something the dollar did without fireworks over the last seven months.  Enacting the BAT with an alternative tax for importers is a real solution that lawmakers should support.