Scrap the Border-Adjustment Tax

– June 16, 2017

Adam Smith wisely pointed out what should have already been obvious: “Consumption is the sole end and purpose of all production.”

Regrettably, many have not learned this truth. Observe: Republican House Speaker Paul Ryan and Ways and Means Chairman Kevin Brady favor a border-adjustment tax as part of a plan to reform the corporate income tax. This tax ostensibly would tilt the economic playing field in favor of exports and against imports, allegedly to help American workers. But whenever the government impedes imports, it raises prices and penalizes consumers — and American workers are consumers. A pro-worker policy that reduces consumer welfare is like a square circle: impossible.

The Trump administration has given mixed messages on the tax. President Trump has said the tax is “too complicated,” and The New York Times reported that the administration has “dropped any support for the tax.” But a couple of weeks later, he told Reuters:

I certainly support a form of tax on the border because everybody else does.… And that’s not a tax to the consumer, because that’s going to be a tax to companies and it’s going to be a tax to other countries much more so than it is to the consumer.… And what will happen is, don’t forget there is no tax if we make our product in the United States.… That’s a tax if companies are buying their product outside of the United States.… So what is going to happen is 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.

Treasury Secretary Steve Mnuchin says, “There’s many aspects of it we like. There’s certain things we’re concerned about. What we discussed with [Ryan and Brady] is we don’t think it works in its current form, and we’ll continue to have discussions with them about revisions that they will consider.”

A border-adjusted tax would treat exporters differently from importers and wholly domestic producers by allowing exporters to deduct from their taxable income not only what they spent on their inventories (whether for export or not) but also all revenues from exports. (It would thus make the corporate tax more like a value-added tax.) In contrast, importers could not deduct the cost of their imported inventory, and companies that bought only U.S-made inputs and sold their products only in the United States could deduct their inventory costs, but not revenues from sales. The tax supposedly would encourage exports, discourage imports, and keep American companies from moving abroad. The tax also would supposedly strengthen the dollar and shrink the “trade deficit” by reducing imports and hence the number of dollars abroad. But any benefits here would be offset because, as tax specialist Tony Nitti explains, “revenue … earned from overseas will suddenly not be worth nearly as much [in dollar terms] as it once was, and so neither will [an exporter’s] revenue.”

Trump and others may think consumers would be unscathed, but that analysis is wrong. As economist Richard B. McKenzie explains, “Since U.S. producers would not pay the tax on profits from exports, the BAT will increase their efforts to sell goods and services abroad, and reduce the resources they devote to producing goods for the domestic market. The greater demand on domestic resources can be expected to increase producers’ domestic prices, which is how Mr. Trump expects real wages to rise for U.S. workers.”

However, import-oriented retailers (who oppose the tax) and non-exporting firms will find a smaller demand as their prices rise. “The collateral damage will be a reduction in the market demand for workers in these disfavored industries,” McKenzie writes. “In a world of scarce resources, encouraging exports must come at the expense of other goods produced.”

That’s hardly the end of the problem. McKenzie adds:

The higher prices U.S. producers and retailers must pay for their inputs from both domestic and foreign sources will drive up prices for consumer goods, undercutting any real wage increases for worker groups in the export industries that directly benefit, and reducing the real wages of workers in industries that do not experience an increased demand for their labor. Those workers would pay the higher prices generated by the BAT for the benefit of the “protected” worker groups.

Where are the benefits?

Finally, proponents of the tax insist it will shrink the U.S. “trade deficit,” but why would that be desirable? A deficit in the merchandise trade account is necessarily offset by a surplus in the capital account: the dollars foreign sellers don’t use to buy American-made products are used instead to invest in America. (See chart here.)

Thus the policy makers have yet to learn another bit of wisdom from Adam Smith: “Nothing … can be more absurd than this whole doctrine of the balance of trade.”