February 22, 2017
Senior Policy Analyst
February 22, 2017
In recent weeks, the Republican congressional leadership’s effort to introduce a comprehensive tax reform bill has increasingly faced opposition from major business groups and skeptical lawmakers from across the aisle. The primary source of dissent thus far is that the most prominent tax framework, the House GOP’s “Better Way” tax blueprint, contains a radical provision to apply a border adjustment to pay for a cut in the rate from 35 to 20 percent.
A new report from the Institute on Taxation and Economic Policy (ITEP) released today finds that this border adjustment tax would be regressive and loophole-ridden and would likely violate international trade agreements.
Under the proposed border adjustment, companies doing business in the United States would no longer pay corporate income tax on revenue earned from exports and would no longer be able to deduct the cost of imports from their corporate income tax liability. Because the United States currently runs a significant trade deficit, applying the tax at a 20-percent rate on imports and exempting exports could raise about $1.2 trillion over the next ten years.
It is important to note from the outset that even assuming the U.S. could raise a substantial amount of revenue from the border adjustment, the House GOP plan would still decimate federal revenue. An ITEP analysis finds that without the border adjustment provision, the House GOP plan would lose $2.5 trillion on the corporate side, and $4 trillion as a whole, over 10 years. In other words, even with the border adjustment the House GOP plan would fall $2.8 trillion short of its goal of revenue neutrality overall and would result in a $1.3 trillion revenue loss from the highly progressive corporate income tax.
The problems with the primary component of the House GOP’s corporate tax proposal go well beyond its revenue effects however. To start, the border adjustment likely would make the corporate income tax substantially more regressive. The inability of companies to deduct the cost of imports could substantially raise the tax rates paid by import-dependent industries such as retailers. To maintain profitability, import dependent industries would be forced to raise prices and pass on the cost of the tax to whatever extent possible. This means that a significant portion of the border adjustment tax would be paid in the form of a regressive tax on consumers. One recent estimate found that the bottom 10 percent of taxpayers may see their taxes go up by 5 percent of their pretax income, while the top 10 percent of taxpayers would only see their taxes go up by about 1.5 percent of their pretax income.
One of the major arguments that proponents of the border adjustment tax make is that it would stop corporate tax avoidance. It is certainly true that the border adjustment would remove companies’ incentive to use certain existing loopholes in our current system, but it would create numerous new opportunities for tax avoidance through the shifting around of sales. For example, Microsoft could avoid the tax by selling its software to consumers in the United States directly from servers in Ireland or another tax haven. At this point there is no reason to believe that following a tumultuous transition to a border adjusted tax that our tax system would end up less prone to tax avoidance than our current system.
And the transition to a border adjustment tax would certainly be tumultuous. Legal experts agree that it would likely be in violation of international agreements. Most importantly, the border adjustment is likely to be ruled illegal by the World Trade Organization (WTO) as an export subsidy. This is because the tax would favor domestic products over imported ones by allowing domestic producers to deduct compensation expenses, but would not allow the same deductions for imported products. A negative ruling by the WTO would mean that the U.S. would have to change the border adjustment tax into a proper tax on consumption, repeal the tax entirely or face retaliatory tariffs.
Given the myriad of problems that it creates, lawmakers should reject the border adjustment tax in favor of fixing the corporate income tax system that we have. The most effective way to accomplish this would be to end the ability of companies to defer paying taxes on their offshore income. While this approach has received less attention from the media, it has gotten a fair amount of high profile bipartisan support from lawmakers in the past. Both Democratic Senator Bernie Sanders and President Donald Trump called for ending deferral as part of their tax reform plans during the 2016 presidential primaries. On the Senate Finance Committee, Democratic Senator Ron Wyden and former Republican Senator Dan Coats introduced a bipartisan tax reform bill that would also have ended deferral. Taking this approach would have the benefits of raising a substantial amount of revenue and curbing tax avoidance without the daunting fairness and legal problems posed by a border adjustment.