For many, the question isn’t whether we’ll have corporate tax reform this year, but when — and whether that reform will include a border tax. The answer to the latter is “Yes,” according to Tom Wheelwright, founder of accounting firm ProVision. “There’s no question about it.”
“Paul Ryan has been dying to do this for years, he has a Republican Congress behind him, and the Democrats don’t have a huge objection to it,” Wheelwright said. “We’ll get lower corporate tax rates, and a repatriation amnesty. And clearly, there will be some form of a border tax.”
“Other countries are against it. They say it’s illegal under the [World Trade Organization] and are threatening a trade war. But they all have it — it’s called a value-added tax. Exports are exempt, and imports are taxable.”
The challenge is that we’ve never had a VAT in the U.S., Wheelwright said: “The proposal is the equivalent of a VAT, but it’s using the income tax law. You don’t get to deduct the cost of goods sold that you purchased outside the U.S.”
“Say that Walmart imports everything from China,” he explained. “If the cost of goods sold is 30 percent, the gross profit ratio is 70 percent. They would normally get a deduction off of gross income for the 30 percent, but in Walmart’s case, if they buy everything from overseas they will be taxed not at 70 percent but at 100 percent of their gross income.”
“For some corporations, it may wash out because the proposed reduction from an effective rate of 40 percent to 20 percent may be enough to offset the fact that the cost of goods sold is no longer deductible,” he added. “But for others, it could have a huge impact. It’s been estimated that it could increase prices to consumers by 10 to 15 percent.”
“It’s the equivalent of a 10 percent VAT. The difference is that a VAT applies equally to all goods sold in a country. If it were possible to buy a car that was made entirely in the U.S., without any steel or parts from outside, that car would have 10 percent tacked onto the price, the same as if it was entirely made outside the U.S.”
“When a U.S. company manufactures inside the U.S. and sells outside the U.S., under the border adjustment proposed in the GOP House Blueprint, it would not pay the tax. So it favors exporters and punishes importers, and that’s true of any border tax. So, a border tax is discriminatory against imports but a VAT is not,” he said. “That’s the argument that the European Union and Asian countries make against it.”
In fact, one of the fears expressed by the right-leaning Center for Freedom and Prosperity is that the World Trade Organization is unlikely to approve the tax as proposed, increasing the odds that it will turn into a straight VAT — and that will undermine international tax competition and make it easier for governments to raise taxes in the future, according to the organization.
The CF&P also disputes the notion that border adjustments would not distort trade, and that exchange rates would react almost immediately to offset the impact. “There is reason to doubt that currency will adjust as completely as proponents suggest, leaving many consumers left paying higher prices,” it stated.
Under World Trade Organization rules, border adjustments upon export are permitted for consumption-based taxes, but are not permitted with respect to income taxes, observed Speaker of the House of Representatives Paul Ryan in the “Better Way” Blueprint. “With this Blueprint’s move toward a consumption-based tax approach, in the form of a cash-flow focused approach for taxing business income, the United States now has the opportunity to incorporate border adjustments in the new tax system consistent with the WTO rules regarding indirect taxes,” he stated.
But the border adjustment, whatever form it takes, could face challenges, according to Selva Ozelli, a CPA and international tax attorney. “It may fall outside the definition of taxes in the 2016 Model Tax Convention,” she said. “Moreover, it may violate World Trade Organization rules by imposing a de facto import tariff, which could be deemed a prohibited subsidy.”
THEORY VS. PRACTICE
“The theory of a border adjustment is that exchange rates or prices would adjust over time and there would be a stronger dollar, which would compensate for border adjustments,” said Don Reiser, managing director and leader of the international tax practice at Top 10 Firm CBIZ. “At the end of the day, if economic theory holds, even though there’s no deduction for the cost of imports, the real pretax cost of those imports goes down due to an offset either on the price or currency adjustment.”
Whether a price adjustment or currency adjustment happens, and how quickly it happens, is a concern, Reiser indicated. “If it doesn’t happen quickly enough, it produces winners and losers,” he explained. “Importers are concerned that there would be a net cost to them, which could result in increased prices to consumers.”
The border adjustment is a critical feature of the House GOP Blueprint, Reiser noted. “It is projected to generate huge amounts of revenue,” he said. “It’s the mechanism to pay for the tax rate reductions. Without it, there’s no way to pay.”
Of course, there’s a risk to it, he indicated: “If they do it and it holds true to the way they project it, there shouldn’t be a cost. But if they’re wrong, there could be a big cost. They may try to phase it in over time to make everyone comfortable and to see the impact. No one knows how it would ultimately play out, so it does create a measure of risk.”
Opponents of border adjustment that say that it is too easy to raise revenue are exactly right, according to Wheelwright: “If you raise the rate by 1 percent you raise a lot of revenue, because it’s a gross receipts tax,” he said. “And it offsets the concerns that tax reform might do to the budget.”
“A border tax or a VAT is a hidden tax, like the tax on gasoline,” he observed. “The sticker on the pump tells you what you’re paying in tax per gallon, but no one pays any attention to it — it doesn’t stop us from buying the gas. There’s no question that prices may rise, but it won’t stop international commerce. I’m not going to stop buying a BMW just because there’s a border tax. I might drive my old one for another year, so it has a cooling effect from that standpoint, but it’s a global economy and businesses will continue to buy and manufacture from overseas.”
As with the Tax Reform Act of 1986, this year’s tax reform will have unintended consequences, Wheelwright predicted: “Not all of them will be bad. For example, a corporate tax rate reduction will have at least a short-term positive impact on the stock market. And a boost to the economy will put many in the ‘underemployed’ category back to full-time employment so the government can stop paying to them and begin collecting from them.”
Roger Russell is senior editor for tax with Accounting Today, and a tax attorney and a legal and accounting journalist.