Border Adjustment Tax Debate

February 8, 2017

There has been a lot of talk recently about the “border adjustment,” a proposed change to the U.S. tax system that is part of the House Republicans’ tax reform plan. In fact, House Speaker Paul Ryan (R-Wis.) and House Ways and Means Committee Chairman Kevin Brady (R-Texas) have started a full-campaign to make border-adjustment business tax a part of comprehensive tax reform, and the Speaker has even set out an ambitious timeline for passage of a tax reform bill by August.

The border adjustment is a way of modifying the current U.S. income tax. Currently, the income tax applies to businesses’ income from production in the U.S. Under a border adjustment, the income tax would apply to businesses’ income from sales in the U.S. As the law stands, if a company makes a product in the U.S. and sells the product overseas, it is required to pay income taxes to the U.S. on the income from the sale. But under a border adjustment, companies would no longer be required to pay income taxes to the U.S. on their income from exports – because the products are not sold in the U.S.

On the flip side, under the current tax code, if a company sells a product in the U.S. that was produced overseas, it does not pay income taxes to the U.S. on the value of the imported product. But under a border adjustment, companies would be required to pay income taxes to the U.S. on the value of their imports – because the products are sold in the U.S. In total, under a border adjustment, the income tax would apply to goods produced and sold in the United States and goods produced in foreign countries and sold in the U.S.

Those supporting border adjustment have argued three main reasons for implementing it.

  • To raise revenue in the least distortive manner, in order to lower overall rates for U.S. taxpayers:

The Tax Foundation estimates that, in the context of the House Republican tax plan, the border adjustment would raise $1.1 trillion over 10 years, and would do minimal economic harm. This revenue would go toward lowering the corporate income tax rate from 35 percent to 20 percent. Without the revenue from the border adjustment, the proposed corporate tax rate would have to rise to 27 percent to keep the cost of the plan the same.

  • To protect the U.S. tax base by improving business incentives:

Every tax system needs measures to prevent companies from avoiding taxes, and the border adjustment is the main provision that accomplishes this in the House Republican tax plan. By changing the system from taxing companies based on where they produce to based on where they sell, the border adjustment would reduce businesses’ incentives to move their operations and headquarters to low-tax countries, use transfer pricing to shift income abroad, and move intellectual property to tax havens.

  • To simplify the business tax system:

Currently, U.S. businesses spend $150 billion a year complying with the U.S. tax code, much of that devoted to navigating the complex set of provisions that deal with income earned overseas. The border adjustment would replace most of these complicated international tax rules.

Those concerned about the implementation of a border adjustment tax have argued that the House Republicans’ proposed border adjustment may violate the rules of the World Trade Organization (WTO), which does not always allow member countries to make their taxes border-adjusted. As a result, the border adjustment could create some business uncertainty until the WTO makes a determination about its validity.

Another potential concern of the border adjustment is that if it is not carefully designed, it may end up disadvantaging certain exporters, who would not receive a full tax rebate on their exports, but would still be hurt by the stronger dollar. It will also be challenging to make sure all imports and exports, including services, are subject to the tax because the location of services are sometimes hard to define. Finally, lawmakers have not yet clarified how the border adjustment will apply to direct sales from foreign businesses to U.S. individuals, which is an important policy design question that needs to be answered before a bill can be passed.

The border-adjustment tax has been the subject of intense lobbying efforts in recent months and those efforts are expected to continue for both sides of the debate. Chairman Brady has said that his panel is working on finalizing elements of a bill in the weeks and months ahead, and thinks that the “optimum schedule” would be for tax reform to be completed by the summer.