Wall to Mexico is not worth the Border Adjustment Tax
On January 26, President Trump hinted at a deal with Congressional Republicans for the wall. He almost endorsed the GOP House Border Adjustments Tax (BAT) with a condition attached. He wants the revenue attributable to Mexican imports to pay for the highly controversial Border Wall. Clearly, President Trump desires a quick win to keep his campaign promise. Since the President of Mexico canceled his meeting with the President over the issue, Trump must find some means of securing the funding. His campaign promise reflected that Mexico would pay the costs. Possibly, House Republicans persuaded the President to accept the BAT in exchange for his wall. However, this is a poor substitute and not worth the potential economic damage. The BAT is massively distortive, leaves a gaping hole in our tax system and fails to support American Industry by targeting too much.
First, the Border Adjustment Tax replaces the current corporate tax code. The President plans to redirect revenue that would already be owed to the U.S. Under the current tax code, any of this money owned by U.S. corporations is already taxable. But the U.S. government defers payment till corporations bring it back to the US. Most do not to avoid the taxes. The BAT is intending to replace that system.
Massive Distortive Effect on the Economy.
The BAT taxes all imports and American produced products at a rate of 20 percent from everywhere. If it is sold in the US, the tax is applied on the sale. Now if the product is made in the U.S., those costs can be deducted from the total sale value. So a box produced in the U.S. is taxed only on profit, but a product from Mexico is taxed on its full sale value. So an importing company has a choice increase prices to compensate or take a massive tax hit. But a box made in the US and sold overseas is never taxed, and the costs in making the box can be deducted from the company’s taxes. Exporting companies get an incredible windfall.
What the President ignored today was the strengthening dollar theory. Economic defenders of the BAT argue that currency markets will automatically adjust to strengthen the dollar as a response. However, most market analysts suggest that the dollar response will be partial and incremental. Skeptics believe the currency value change will be minuscule. This means there will be a price wedge on products. All imported products will be more expensive. This deceptively great distortion allows all manner of games to be played with commodities. While the President was against this stronger dollar last week, he seems willing to accept it now to declare a symbolic victory on the wall. But the detriments to our economy are huge and should not be taken lightly.
Games of tax avoidance that can be played.
Most tax analysts are well aware that corporate taxes are avoided by large multinationals now. But the obvious potential tax avoidance strategy under BAT staggers the mind. To avoid the domestic taxes under BAT, domestic companies can purchase exports going overseas. The distortion allows the ratio to get enough costs to offset the domestic taxes.
Companies that export who will not derive benefit from the tax deduction can sell their products for a slight commission to another company that needs to avoid Uncle Sam’s taxes. This loophole wipes out huge swaths of Domestic corporate tax collected. It would certainly take away any savings President Trump wants for his wall. The American people would have to make up the difference.
Ordinary Citizens get hurt by not distinguishing between imports.
Not all imports are equal. Some imports have current active competitors in the U.S. Most of these products are necessities, such as food, clothing, etc. The BAT will force most importers to pass the costs on to the consumers. These consumers are primarily middle and lower income Americans. So in fact, Mexico is not paying for the wall. The American citizens bear the burden. And the greatest burden is borne by our most vulnerable. President Trump may need a win on the wall, but not at this price. The BAT is an apt acronym. Because President Trump is using a bat where a scalpel is called for. Tariffs can have their place, but they must be used wisely and judiciously.
The BAT is not the Destination-Based Tax reform you are looking for.
Unfortunately, not enough people know about Destination Based Sales Factor (DBSF). The BAT has too many flaws. Pairing a Destination-based collection system with an origin-based costs deduction system cannot work. It tries to solve too many ills at one time. Tax reform should be aimed at solving one major malady: heavier taxes on smaller American companies. These are domestic companies that actually pay close to 30 percent or more in taxes. Meanwhile, large corporations pay half of that rate or less and then use the smaller companies as props for advocating lower tax rates for themselves. We need a tax system that fixes this unfairness. Destination- Based Sales Factor is the means to do that.
Sales Factor pairs destination-based tax collection with destination-based costs because it focuses on Profits from imports and exports instead of sales. This leads to no economic distortions, no unfair tax advantages, Hard if not impossible to manipulate tax systems and encourages businesses decisions to occur independently of tax rates and policy.
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