Everybody loves tax reform.
At least, that’s the conventional wisdom in Washington. And what’s not to love? The tax reform plan being discussed in 2017 involves lowering corporate tax rates to 20-25 percent, immediate expensing for capital expenditures, and repealing the much despised “death tax,” which imposes an absurdly high inheritance tax on the transfer of wealth and family businesses between generations. These are all long overdue and all promise to make our tax system fairer, simpler and more internationally competitive.
But there’s a catch.
To offset the lost tax revenue that Uncle Sam will no longer collect because of lower tax rates and other measures, including other provisions not mentioned above, the House Republican leadership is also proposing to “border adjust” all corporate income taxes. The Border Adjustment Tax (BAT) is estimated to raise $1.2 trillion over 10 years. It does this by denying the current deductibility for cost of goods sold (COGS) when those costs are associated with imports, while excluding all export and foreign-license revenue from income taxes. They are proposing other measures to offset revenue loss, too—like removing the deductions for interest—but this BAT is the big one. Exporters make out well.
Tax-free income seems pretty nice. But what does this mean for importers? In plain English, the cost of every imported item or input (fabric to manufacture clothing, for example) would increase by 20-25 percent (depending on your company’s corporate tax rate). Although details had not yet been released at press time, the House Republicans’ “A Better Way” tax proposal makes it clear that “products, services and intangibles that are imported into the United States will be subject to U.S. tax regardless of where they are produced.” This would tax everything you import to sell, including bags and totes, apparel, drinkware, writing instruments and electronics, as well as many things you use that are produced using imported goods, such as shoes, gasoline, food, cars and trucks. The BAT tax would affect imports from every country, including free trade agreement partners. No exceptions. Let’s see how this works in practice with an overly simplified example.
Suppose you import promotional backpacks at an average import cost of $10. You pay $1.76 in tariffs (17.6 percent rate) and overhead—including costs of embroidery in the U.S.—of $8.74. Your unit sale price is $21.51, netting a pre-tax profit of $1.01 and a tax bill (at a rate of 35 percent) of 35 cents. Under the BAT, the math changes significantly. Your corporate tax rate now drops to 20 percent, which is fantastic. But that lower rate now taxes a much higher base—your profit and the price you pay to import the backpack and the tariff you pay when you import the backpack. That’s right, you pay an income tax on the tariff. Now your total income tax bill explodes to $2.55, which is seven times the amount you paid before and now means you’re paying an effective tax rate of 255 percent.
Clearly, you can’t run a business when the government taxes more than 250 percent of your profits. So you will try to pass these costs along—in the form of higher prices. But this may not work in a price-sensitive industry such as ours, as higher prices may force customers to choose a less-taxed advertising medium (print or radio perhaps), lower the number of items purchased or choose less expensive promotional products. You could try to cut overhead, but don’t forget that your other costs—such as energy—are also going to increase since everybody else in the economy will also face their own inflationary pressures due to the BAT.
Proponents tell us that this won’t happen. They argue that the BAT will instantaneously cause a substantial increase in the value of the U.S. dollar, immediately lowering the cost of imports, which would shield importers (and their consumers) from cost increases. Yet that scenario—based on a theory that even economists can’t agree upon—provides cold comfort. Most import transactions, and certainly nearly all those in the promotional products industry, are denominated in dollars. Moreover, currency rates are affected by many, many more factors besides trade flows. So the thought that (a) an exchange rate change would happen; (b) if it did, it would happen instantaneously; or (c) that such changes would enable contracts to be easily renegotiated is pure fantasy.
Proponents also argue that the BAT is needed to align U.S. tax policy with that of other countries. They point to the system of value added taxes (VAT) that other countries use to conjure up an imaginary “Made in America” tax. Those VATs are imposed on imports from the United States (and other countries) and are rebated on exports to the United States (and other countries).
Since these VATs are border-adjusted—so goes their logic—it is only fair for the U.S. to do the same. What they fail to mention is that those VATs are border-adjusted sales taxes, while the House-proposed BAT would border adjust the U.S. corporate income tax. Moreover, if the U.S. succeeds in doing this, it would be the only country that is border adjusting its income tax. To make matters worse, enactment of the BAT could easily trigger a tax and trade war, as our trading partners retaliate by imposing countervailing measures. Some have already threatened to do so.
In the longer term, the U.S. is likely to see a challenge in the World Trade Organization (WTO), since this plan would appear to violate several key WTO principles. If successful, a WTO challenge would enable other countries to legally impose punitive tariffs on U.S. exports—to the tune of $385 billion, according to an estimate by the Peterson Institute for International Economics. It’s no wonder small and large businesses alike feel the BAT is an existential threat. A coalition of more than 400 businesses and trade associations, including PPAI and the American Apparel & Footwear Association (AAFA), have come together under the banner of Americans for Affordable Products (AAP) to push for comprehensive tax reform that does not contain the BAT.
So what happens next? House Republicans expect to publish details of their tax plan before summer, while Senate Republicans, who have expressed concerns over the BAT, are actively exploring other options. The Congressional leadership, along with the White House, has labeled tax reform a priority and most experts agree that some form of tax reform can get approved by this Congress.
It’s been more than 30 years since the last significant reform of our tax laws, and there is a consensus that the time is right. But the BAT has emerged as a deeply controversial element that may slow down the process or derail it entirely. Although one of the intellectual fathers of the BAT concept believes that tax reform can occur with or without the BAT, proponents continue to insist that the BAT is the glue that holds the entire tax reform proposal together. Will tax reform contain some form of the BAT? It’s too early to tell. But one thing is certain. Now is the time to speak up to ensure that tax reform is done in a way that benefits our companies and our industry.
And if we are not vocal, we may find that everybody does love tax reform—except us.
Stop The Proposed Border Adjustment Tax
Add your voice to the growing number of industry members opposing the Border Adjustment Tax (BAT). Details of the House Republicans’ plan is expected to be published before summer but there may still be time to support the opposition. Contact your member of Congress today and request a reform of the tax code that won’t negatively affect American workers. To find out who to call and what to ask for go to cqrcengage.com/ppa/makeacall.
Stephen Lamar is executive vice president at the American Apparel & Footwear Association (AAFA). He is responsible for the design and execution of AAFA lobbying strategies on a series of issues covering trade, supply chains and brand protection. In these roles, Lamar also advises AAFA member companies on legislation and regulatory policies affecting the clothing and footwear industries. He is also president of the Washington International Trade Association (WITA), a non-profit, non-partisan organization dedicated to providing a neutral forum for discussion of international trade policy and related issues.