The case for border adjustability in pro-growth tax reform
President Trump and House Republicans have proposed tax reform plans that share many commonalities.
Both plans call for a lower, competitive corporate tax rate and replace the outdated worldwide system of taxation with territoriality. Each plans reduces the number of individual tax brackets from seven to three and doubles the standard deduction. They repeal the Death Tax and the Alternative Minimum Tax.
{mosads}One area where there is less clarity is where the White House stands on border adjustability (or the BAT as critics call it).
On one hand, the tax reform principles Trump released did not include border adjustability. On the other hand, as recently as this week Trump called for a “reciprocal tax” on foreign imports similar to what other countries apply to U.S. exports.
While debate has centered on the direct merits or drawbacks of border adjustability, less attention has been paid to the fact that it helps achieve other goals of tax reform.
Border adjustability is not a take-it or leave-it proposition. Instead, it is a cog in a machine that facilitates tax cuts in other places, territoriality, and permanency. Border adjustability is not the only option, but removing it comes at the cost of important goals. Any real alternative must address these issues.
In the House Republican plan, border adjustability is used as a base broadener that raises as much as $1.2 trillion in revenue over a decade to offset other tax cuts for small businesses and corporations.
This offsetting revenue also allows permanent tax reform to be passed through budget reconciliation and be made permanent. Revenue neutrality is needed here because legislation that adds to the deficit outside the ten-year budget window is not reconciliation compliant.
Permanency should be a goal of tax reform for two reasons.
First, permanency gives certainty for taxpayers who don’t need to be concerned their taxes will rise in a years to come. Second, low-tax politicians do not need to devote political capital year after year to ensure tax cuts are reauthorized.
For this to be possible, offsets like border adjustment are needed.
Including border adjustability in tax reform also helps get to a territorial system of taxation. The U.S. is one of the few countries in the world with a worldwide system of taxation, which means businesses operating overseas are taxed twice – once when they earn income in the country they are operating and again when they bring this money back to the U.S. to reinvest.
A border adjustment system is a key part of territoriality because it ensures business activity is taxed only where the product is consumed. Exports that are consumed by individuals outside the country are not taxed, while imports consumed by individuals inside the U.S. are.
Border adjustment also addresses the U.S. tax code’s base erosion problems, which allows income that should be taxed by our system to instead be taxed by more efficient, low tax countries. Under a border adjustable system, consumption – not income – is taxed.
Other solutions that have been proposed to address base erosion and achieve territoriality create many more problems than they fix.
A new minimum tax on international earnings, like the 19 percent tax proposed by former President Obama, would strengthen the double taxation of the existing worldwide system, add to the complexity in the code and grant broad authority to the IRS to enforce already complex rules.
Another option, a European style Value-Added-Tax should be considered a non-starter. Opponents of border adjustability have misleadingly compared it to a VAT by labeling it a “BAT.” However, there is a clear difference – the border adjustment is a component of a cash-flow corporate tax, while a VAT is a new tax that is layered on top of a corporate tax.
Because it is layered on top of every stage of production and has a base that includes employee compensation, the VAT is a tool that leads to bigger government and higher spending. Creating new taxes in tax reform is the wrong choice to make and would impose a bigger and even more intrusive government.
It is inevitable that tough choices must be made if tax reform is to be signed into law in 2017. Border adjustability in tax reform helps get to lower rates, territoriality, and permanency. Removing it necessitates an alternative, or giving up on these important objectives.
Alexander Hendrie is director of tax policy at Americans for Tax Reform.
The views expressed by contributors are their own and are not the views of The Hill.
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