Is a Border Adjustment Tax (BAT) just Batty?
By Jon Aldrich
We all know by now that President Trump aspires to build a wall between the U.S. and Mexico and he has stated that he is going to have Mexico pay for it. You may wonder, How is he going to get Mexico to do this? Enter, the Border Adjustment Tax.
What is the Border Adjustment Tax?
Ok, let me try to explain this without getting too complex or overly nerdy. Currently, the U.S. corporate tax system is considered an origin based tax system because corporations are taxed on their income no matter where the goods are produced. Thus, a company can deduct the cost to produce inventory whether it was made in the U.S. or not, as well as, overhead expenses such as wages, interest, depreciation, advertising, etc. Total sales less these expenses equal taxable income and this amount is taxed at 35%. It doesn’t matter if the goods were sold inside or outside of the U.S.
Under the GOP corporate tax reform proposal, the corporate tax rate would be cut to 20%. A company could deduct the costs to produce its inventory if it was made in the U.S. but could not deduct it if it was imported. A company would also be able to expense equipment purchases immediately rather than depreciating over time. Another wrinkle in this is that a corporation would be able to exclude from revenue the portion of its goods that are exported to other countries.
Let’s look at a crude example of how 2 companies might fare under the new proposal. Assume that both companies have $10 million in total sales, their total cost of inventory sold is $5 million but where they produce their inventory for sale and where they sell their goods are completely different. They also have $1 million in other expenses.
COMPARISON OF PRE-TAX CASH FLOW and EFFECT OF BORDER ADJUSTMENT TAX
Both companies have the same amount of net income before taxes. But that is where the similarities end since Company B imports a lot of their inventory and does not sell outside the U.S. they pay a hefty cost. Company A, however gets rewarded big time by producing the goods in the U.S. and selling a lot of it overseas.
You can see under the GOP Border Adjustment Tax Proposal that it really makes it worthwhile for companies to produce their goods in the U.S. and sell them overseas. The proposal allows companies to reduce their income by the amount of goods exported and requires companies to add back to income the cost of inventory that is made outside the U.S. This is where the 20% tax on imports comes from.
Sure, President Trump campaigned extensively on a big border tax and a lower corporate income tax rate to help make America great again. However, House Republicans had the blueprint for this in the works well before Trump earned the party nomination. In fact, Trump has been on and off in regards to support of this proposal, but it is assumed that he generally supports the concept of it. There are also several economists on the left and the right that are embracing this proposal. The fact is that a lot of other countries around the world have a similar tax referred to as a V.A.T. (Value Added Tax).
Ok, so how does this all get Mexico to pay for the wall? See this from Marc A. Thiessen in the Washington Post recently:
To keep this all somewhat readable, I am leaving a lot of other details out of this topic that still need to be resolved, such as:
- There is only a “blueprint” in place no actual bill just yet.
- Will the World Trade Organization (WTO) object to this?
- Since the tax rate is coming down, the deduct-ability of other current deductible expenses is up in the air. Things such as wages, interest expense and advertising to name a few may not be deductible to increase taxes collected from the drop in the tax rate.
- If there are not enough other tax offsets in the proposal to increase tax collections, will the Federal deficit continue to deepen?
- Will companies just pass along the tax on imported goods to the consumer? Will your Corona cost 20% more? Will it really hit low wage earners hard as a lot of the goods they buy at places such as Walmart may be more expensive?
- Will this make the U.S. dollar even stronger if enacted?
- You know the big importers such as Walmart and others are going to throw a lot of money in to defeat this proposal?
- How realistic is it that this proposal becomes law?
There are probably a lot of other questions that will come up. But the reality is that you are going to hear a lot more about the Border Adjustment Tax the rest of the year and possibly beyond. Hopefully, you now know enough about the basics of how it works so that it will make a little more sense.
Here are a couple other articles that might give you a much deeper perspective of the Border Adjustment Tax:
As the debate on corporate tax reform heats up, there are a lot of issues to work through. It remains to be seen if it will be accomplished in 2017. Stay tuned.