Is a border adjustment tax really just a plain old tariff?

May 5, 2017

Dear Cecil:

What's the difference between a border adjustment tax and a tariff? The New York Times says a BAT of 20 percent on imports would “satisfy [President] Trump’s protectionist impulses without imposing punitive, and potentially even more disruptive, tariffs." A tax is a tax, right? How is a tariff punitive while the BAT isn’t?

Cecil replies:

A tax is a tax? Maybe, Frank, and maybe not. In trade, as in so many matters, our current administration's eventual path is anybody's guess; Team Trump made noises early on suggesting an inclination toward protectionist tariffs, but (naturally) details and follow-up have been nonexistent. Some Republicans in Congress, on the other hand, have done more of their homework, and they're calling instead for a drastic overhaul of how we tax businesses in the first place — which, incidentally, might have many of the effects on our trade balance Trump seems to want.

As economic-policy weaponry goes, a tariff is a blunt instrument, used to bonk a targeted problem over the head — a trade partner who’s squashing some domestic industry, or otherwise acting up. If the U.S. government wants to dissuade me from cutting labor costs by moving my widget company overseas, threatening to zap me with a 35 percent re-import tariff — as then-president-elect Trump suggested back in December — is one way to do it. And levying a tariff on Chinese widgets would give a boost to those widget makers who loyally remain on American soil. But China would be likely to retaliate by imposing its own tariff on American widgets, which certainly wouldn’t help the U.S. makers compete in the lucrative Chinese widget market. Want a trade war? You got one.

Beyond the often-deserved “punitive” tag, tariffs just have a lousy rep: Econ 101 professors tend to bad-mouth them, as they distort the workings of the smooth-running, rational free market that economists like to think the world resembles.

So how does the congressional GOP’s border-adjustment plan work? It’s complicated (as you’d hope, really), but very basically the idea is to retool our current corporate tax system, where income is considered income, pretty much, into one where (1) everything sold in the U.S., domestic or imported, gets taxed, meaning American companies would now pay taxes on all goods, parts, and materials they ship in from elsewhere; but (2) their sales revenue from exports is no longer taxable.

In effect, companies would be taxed primarily on the basis of where they sell their stuff rather than where they make it. Suddenly my offshore widget factory isn't saving me the bundle it once was, since I’m paying to bring the product back to the U.S.; meanwhile, stateside manufacturers have a new edge in foreign markets, where they won’t have to bundle income tax into their prices. The U.S. trade deficit being second to none, plenty of tax money gets generated on imports, and American companies have less reason to leave foreign revenue overseas.

Significantly too from an international comity perspective, a border adjustment tax doesn’t have that punitive-tariff smell — instead of singling out one class or source of imports, it's applied across the board. And it shouldn’t cause harmful distortions in trade, say the economists: the tax relief on exports will cancel out the effects of the hike on imports.

The BAT is essentially a subspecies of value-added taxation, where businesses pay sales tax on goods throughout the supply chain. Lots of nations, particularly in Europe, use VAT, rather than relying on income taxes like the U.S. largely has; the BAT plan, the theory goes, would help our system sync up better with theirs.

That’s great, you say, but hang on: doesn’t all this mean I’m going to be paying more for widgets? So one might think, at least in the short term. Intuitively, a border adjustment tax could mean saying goodbye to all those cheap foreign-made clothes, appliances, and other goodies we've been buying at Walmart for years. It's no surprise that one of the leading Republican voices against an import tax is Senator Tom Cotton, who represents the retail giant's home state of Arkansas.

Not to worry, say the plan's supporters. The incentive this new scheme creates for American manufacturing will strengthen the dollar so much that imports will stay comparatively cheap and retailers won't need to raise prices. But let's look at the fine print here: to achieve the effects they're predicting, we'd need to see a 20 percent boost in the dollar's value. You’ll be surprised to learn there’s some difference in expert opinion about how likely this is to happen.

Of course, Republican infighting between BAT advocates and no-new-taxes hardliners may doom the whole thing from the start. As of deadline, the House Ways and Means chairman was insisting BAT is still on the table, though, and maybe foes will determine instead that a compromise is the only way to avert the trade war Trump has often appeared to be hankering for. Then the only wars we'll have to worry about are all those bombing and shooting ones suddenly looming on the horizon.

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