Border Adjustment Tax: Alternatives for American Job Creation

The GOP's Border Adjustment Tax Proposal

The GOP's recent tax proposal included a border adjustment tax that was said to be good for American jobs, as it essentially places a tax on imports. While ideologically speaking the border tax serves as an example of the kind of economic nationalism promoted by Trump during the campaign, the actual effect of the proposal is unclear at best and potentially destructive at worst. This paper examines the issues surrounding the border adjustment tax — where it came from, who is expected to profit from it and who is expected to be hurt by it, what alternatives are available to help create jobs in America, and which alternative might work best to address the issue of job creation that the Trump Administration has been so adamant about solving. The thesis of this paper is that while no single solution presents itself as fully satisfactory (because of the myriad variables surrounding the complexity of trade and job creation), an approach based on ethical consumption laws could prove to be the most beneficial and least damaging compared to other possible alternatives, including the border tax itself.

This paper begins with Part I, which examines the Better Way policy paper released by the GOP in 2016 detailing the border adjustment tax and what the Trump team claims it will accomplish. Part II discusses the winners and losers of the tax, its likely effect on American workers, and its intellectual origins. Part III examines three possible alternatives to the border adjustment tax. Part IV describes which of these three alternatives might be best and how it would theoretically impact job creation in America, as well as other factors relating to the WTO and trade.

A Better Way

The GOP's border adjustment tax proposal was released by the House in 2016 in a policy paper entitled A Better Way. Its focus was on lowering the corporate income tax rate — currently among the highest in the world, behind only the UAE and Puerto Rico — to 20%.¹ To make up the revenue gap, the GOP proposed taxing imports more heavily, an idea that correlates with one of Trump's major themes since taking office: "Buy American, Hire American."² Companies seeking to offshore production and send their products back to the U.S. would face a severe penalty, as Trump assured his base of supporters on numerous occasions.

The proposal moves the tax from an "origin-basis" to a "destination-basis"³ — the aim being to prevent companies from profit shifting. The border adjustment tax proposal is therefore a proposal to change the existing corporate income tax into a destination-based cash-flow tax, as the policy defines it. According to this definition, the border adjustment tax would cancel the corporate tax on earned income from exporting; companies instead would be unable to write off costs related to importing. As Pomerleau points out, the border adjustment tax is a common feature of consumption-based tax systems around the world⁴ — and also in the U.S. itself: "many retail sales taxes in the United States are destination-based and have border adjustments, and most value-added taxes (VAT) throughout the world employ border adjustments."⁵

The difference between origin- and destination-based systems is that in the former, goods are taxed based on the country in which they are produced without respect to the country in which they are consumed. A destination-based tax, which is what the border adjustment tax constitutes, places a tax on products based on the country in which they are consumed without respect to the country in which they are produced. In other words, both domestic goods and foreign imports would be taxed under the border adjustment tax proposal. This differentiates it from a tariff, which targets imports solely. The destination-based tax applies to goods produced domestically as well — so long as they are also consumed domestically.

Team Trump's Claims

Speaker of the House Paul Ryan stated that imports are undermining American products and that he "sees the tax as a way to level the playing field for U.S.-based manufacturers."⁶ Rep. Kevin Brady viewed the border adjustment tax proposal as "a way to end the 'Made in America tax' on exports" as well as a way to reduce offshoring.⁷ Trump himself indicated that the border adjustment tax "could lead to a lot more jobs in the United States," without offering specifics on how it would accomplish that.⁸ Additionally, Trump's top advisor Steve Bannon was described as "the most enthusiastic backer of the border-adjustment plan."⁹ White House Chief of Staff Reince Priebus, Commerce Secretary Wilbur Ross, and trade advisor Peter Navarro also supported the border tax — with the expectation that its implementation could effectively "raise more than $1 trillion over 10 years."¹⁰

The gist of the proposal is that "the tax on imports will encourage domestic production and cause the already strong dollar to rise, offsetting upward pressure on import prices"¹¹ — though the dollar had declined in recent weeks after Trump indicated it was too strong,¹² and Treasury Secretary Steve Mnuchin appeared to agree, noting that a strong dollar over a short period of time "leads to issues that hurt our exports."¹³ Though not explicitly detailed in terms of logistics, Trump's expectation was that "companies are going to come back here, they're going to build their factories and they're going to create a lot of jobs and there's no tax."¹⁴

The Impact of the Border Adjustment Tax on American Workers

Winners and Losers

According to Julian Emanuel, executive director of U.S. equity and derivatives at UBS Securities, the losers of the GOP's proposed border adjustment tax "are the companies that are very reliant on imports in general...apparel, semi-conductors."¹⁵ Companies unable to pass on the 20% increase would be hurt on their bottom lines — including businesses that were prominent in the 1980s but offshored "as costs plunged."¹⁶ Companies in "retail, energy, and auto industries" labeled the border adjustment tax "outrageous," describing it as a "trillion-dollar tax break for some corporations that increases the price of clothing, food, and gas for American consumers." As such, large corporations including Macy's, Nike, Walmart, and Best Buy all came out against the border adjustment tax.¹⁷

Companies that export, however, stood to benefit from the tax — as evidenced by a letter to Congress signed by 16 CEOs of export-heavy businesses. According to them, the tax is a "pro-growth" strategy aimed at fostering American industry and eliminating the "unfair advantage for foreign-based companies at the expense of U.S. jobs and economic growth."¹⁸

While some commentators, such as Pomerleau, have argued that the border adjustment tax would have no impact on trade,¹⁹ others hold that the proposal would ignite a trade war.²⁰ The World Trade Organization (WTO) went so far as to "warn that if the U.S. makes the tax change, it would lead to a major challenge to the global trading system at a time when its most influential member is tilting towards protectionism under Mr. Trump."²¹ Indeed, the potential for a trade war appeared real should the border tax be implemented. As The Wall Street Journal reported in January: "Foreign countries would almost certainly respond if Mr. Trump tried to impose a border tax. They would file cases against the United States at the World Trade Organization, which has the power to authorize retaliatory tariffs on American products, potentially hurting exporters like Boeing, General Electric and farmers in the Midwest."²² China was already objecting to Trump's intention to investigate steel imports,²³ indicating that a border tax would be seen as a further attempt to suppress foreign competition. By all accounts, the border tax would benefit American exporters while hurting importers — but as the Peterson Institute for International Economics has pointed out, "if the reform is found to violate WTO rules by restricting U.S. imports, trading partners could be authorized to retaliate by an estimated $220 billion annually."²⁴ Moreover, should the tax be viewed as a means "to implicitly subsidize exports, partners could be authorized to retaliate by an additional $165 billion annually."²⁵ How the WTO would react to the GOP border adjustment tax proposal depends ultimately on how the plan is judged by the Dispute Settlement Body should members dispute the tax's legality.

On American Workers

The effect of the border adjustment tax on American workers would be beneficial to the extent that it leads to job creation and to more companies choosing to build in America — a phenomenon that Trump promoted as part of his "America First" theme.²⁶ As Colvin notes, the expected outcome of the tax is particularly shaped by economists' forecasts, which means that the American worker may not be as affected as the Trump Administration suggested — namely because "while border adjustment would change effective tax rates... it would also change exchange rates."²⁷ Should the border tax cause the dollar to appreciate against foreign currencies, importers would likely be paying no more than they already are. However, a strong dollar would hurt U.S. exporters²⁸ — and so finding the right balance to keep American companies productive and profitable could be more difficult than simply adopting a border adjustment tax.

The direct impact on American workers is considerably hypothetical — and there are likely a number of variables that could affect their situation, with the border adjustment tax being merely one of them. Isolated as a mechanism to create job growth in the U.S., it theoretically offers a conduit to that goal; however, as Colvin has stated, there is no real precedent for the tax proposal that the GOP put forward.²⁹ Value-added taxes have been used in Europe to positive effect, but the outcome of a border adjustment tax in America could in fact hurt American workers employed by American exporters, as it could "destroy manufacturing jobs, not create them," as Williams reports.³⁰ This argument is made by the Motor Equipment Manufacturers Association, which holds that the border adjustment tax "could raise vehicle prices by as much as $2,500"³¹ — and in an industry that is already over-saturated and in need of deep incentives to move product,³² any cuts in margins could lead to cuts in jobs, as "the global automotive supply chain is complex and integrated into almost every vehicle manufactured, including those made in the U.S."³³ Small businesses that rely on imported parts could equally be hurt by the tax — unless manufacturing in the U.S. were to suddenly grow exponentially and to such an extent that reliance on foreign-labor-produced parts would dissipate quickly. It is this latter prospect on which the Trump Administration appeared to be resting its assumptions.

Intellectual Origins: The True Intention of the Border Tax

If the actual outcome of the border adjustment tax on the American worker is unclear at best, perhaps the tax is being proposed for an ulterior motive. To understand the GOP's proposal, it is helpful to obtain context — to identify the intellectual origins of the border tax. The man described as the tax proposal's "principal intellectual champion in the United States" is an economist at the University of California, Berkeley, named Alan Auerbach — and his goal in promoting the tax is to ensure that "incentives will align with the national interest."³⁴ Auerbach believes the destination-based tax "is an adaptation to the modern economy of open borders and advancing technology" — a system in which multinational corporations are able to shift assets such as intellectual property to tax-friendly countries as a way to protect profit margins. The border adjustment tax would theoretically, according to Auerbach, eliminate "incentives to game the system."³⁵

Auerbach's ideas found political support in Texas Republican and chairman of the House Ways and Means Committee Rep. Brady, who is at the center of the GOP's border adjustment tax proposal. Brady's stated aim has been to "level the playing field for made-in-America products."³⁶ In effect, the tax proposal is a challenge to the World Trade Organization, to free trade agreements such as NAFTA, and to globalism in general. The ideological core of the tax promotes the "America First" theme of the Trump Administration — but in actuality the effect of the tax will not be felt in a vacuum or in a world wholly controllable by Brady, Auerbach, or the Trump Administration. The tax proposal is more akin, in this light, to a thrusting move in an economic match of wits within a much larger game consisting of social, political, and other economic factors and nuances. Auerbach himself has admitted as much, stating, "Economists don't rule the world; I understand that... You never know when or if your policy ideas will have an impact."³⁷ The intellectual origins of the border tax adjustment proposal are thus situated less in a perfectly calculated plan to promote the interests of the American worker than in a nationalistic approach to tax code reform — one that challenges decades of trade policies that have promoted offshoring.

Whether the tax proposal would ultimately benefit the American worker or simply lead to more economic devastation domestically — as multinationals look for leverage to wield against such a proposal — remains in the realm of the speculative.

Conclusion

The GOP's 2016 border adjustment tax proposal is the manifestation of a policy of economic nationalism championed by men like Auerbach, Brady, and Trump — and while the ramifications of the tax may be unclear, the idea behind it is not: it is meant to serve the interests of America first by supporting job creation at home through taxation on companies that offshore. The end goal may not, however, spark the growth in domestic business that is desired, as many small and large companies depend upon manufacturing abroad. An alternative solution to the problem of job creation in the U.S. that takes a similar consumer-based approach is the ethical consumption laws tactic. Unlike the border tax, it is non-punitive and does not punish importers; instead it rewards consumers who purchase American-made products and thus encourages domestic production. While this solution may not be a catch-all that addresses every conceivable negative factor impacting trade and business today, it does offer at least a positive partial solution to the issue of job creation in America. However, any policy that promotes economic nationalism is more than likely to be met with resistance from WTO member states. In order to achieve the aims of the Trump Administration and work toward a solution that addresses the domestic needs of Americans, a diverse and multi-front initiative will be needed.