What is border adjustment tax?

By: Mike Kastner, NTEA Managing Director

Samukele Ncube
Dawson Strategic

Anna Barrera
Dawson Strategic

This article was published in the April 2017 edition of NTEA News.

Tax reform has been on the Congressional agenda for a while, with minimal movement. Since the presidential election, it has become more important. A key reform item for the Trump Administration is the border adjustment tax.

Conceptually, the current 35 percent corporate income tax would be replaced with what is formally known as a “border-adjusted, destination-based cash-flow tax” of 20 percent. Instead of paying the corporate income tax, businesses would pay this 20 percent tax on imported goods and services. It would be the largest corporate tax cut in U.S. history and have numerous effects internationally as well.

Under the border adjustment tax, imports are taxed and exports are exempt. Many countries have similar systems operating in the context of value-added tax (VAT). More than 140 nations use the VAT system — particularly within the European Union. Under the system, a tax is placed on a product at each stage of production where value is added, and then again at final sale when the consumer purchases the end product.

A border adjustment tax, however, is applied based on where a product is consumed, rather than where it’s produced. This is why, in its simplest form, it is a tax on imported goods that simultaneously offers a rebate to domestic companies exporting goods, as the tax is applied based on final product destination.

For example, if a domestic company manufactures items for export, those products would not be taxed under the border adjustment tax as they would be consumed elsewhere. However, if a foreign company manufactures products intended for domestic consumption, those products would be taxed as they would be consumed within national borders.

An often-heard concern is that border adjustment taxes would conflict with international trade laws. Many feel the proposed border adjustment for imports functions like a tariff on goods produced abroad and sold in the U.S.

Border adjustments, unlike tariffs and subsidies, are not part of trade policy. They are adjustments that seek to incentivize domestic companies to increase exports — theoretically resulting in a level playing field for domestic and overseas competition.     

NTEA’s partner in Canada, Dawson Strategic, conducted research into border adjustment taxes. Depending on design, they can be compatible with World Trade Organization rules.

The idea behind a border adjustment system would be to boost domestic production as well as provide greater incentive for domestic companies to export their goods. In addition, border adjustment taxes are believed to eliminate the incentive for companies to move their most profitable production activities abroad to capitalize on lower foreign tax rates.

Proposed U.S. border adjustment tax
In June 2016, the GOP released the tax reform blueprint, “A Better Way: Our Vision for a Confident America.” This proposal included a border adjustment tax, which was partially motivated by criticism that the 35 percent tax placed on a corporation’s global net income is too high and incentivizes U.S. businesses to move offshore.

Under the proposed plan, corporations would be taxed on domestic revenue — less their domestic costs — at the lower rate of 20 percent. The resulting net effect would favor exports.

Canadian implications
United States is Canada’s largest trading partner. Due to its interdependence on the U.S. market, any trade policies or programs put forth by the American government will heavily impact Canada. When the proposal first came out, groups representing the automotive and retail industries in Canada wrote a letter stating the blueprint would create “huge business challenges” for companies relying on global supply chains. Everyday items would also see an increase in price, not to mention vehicles and trucks.

Looking ahead
The tax reform blueprint has received both criticism and praise from various groups. The proposal itself still has a long way to go before it could become law. Currently, little is known about the precise form such a tax adjustment could take. There is also the added obstacle of ensuring a corporate tax structure of this nature would be compliant under World Trade Organization regulations.

NTEA will closely follow this issue in the coming months and keep members informed as updates are available.

For questions on this article, contact Mike Kastner. Visit ntea.com/advocacy for the latest legislative and regulatory news.