Since Donald Trump's surprise election victory, the president and Republican leaders in Congress have described tax reform as a top priority—a once-in-a-generation chance to overhaul the tax code in a way that lowers rates for companies and individuals, encourages businesses to make things at home instead of abroad, and ends incentives for companies to book profits overseas. All without raising the budget deficit.
Republicans in Congress, led by House Speaker Paul Ryan, have come up with what they believe is a key part to the solution: a border adjusted tax, or BAT. Their plan proposes scrapping the 35 percent corporate rate, one of the highest in the world, and replacing it with a 20 percent rate that applies to profits from domestic sales and to imported goods and materials. Money earned from exports would be exempted from a company's taxable income—effectively letting U.S. sales abroad go tax free. By taxing imports the plan would raise about $1.1 trillion in federal revenue over a decade—enough to offset the revenue losses from lower tax rates.
Sounds great, right? Except there's a reason the tax code hasn't been fundamentally changed since the Reagan administration. Entire industries and business models have been built around tiny nuances of the rules, so any change creates big winners and losers. And sure enough, political and corporate forces have mobilized to take sides in what has become the biggest tax fight in almost four decades.
Companies that rely heavily on exports, such as Boeing Co. and Oracle Corp., love the plan—for obvious reasons. Beyond profits, they also say a BAT would make American manufacturers more competitive by putting them on equal footing with foreign competitors around the world.
Importers hate the BAT. Big retailers such as Walmart Stores Inc. and Best Buy Co. contend that border adjustments will dent profit margins and force them to raise prices on everything from avocados and furniture to Nike shoes and French cheese. In a Feb. 28 letter to congressional leaders, the Americans for Affordable Products coalition said the tax would raise consumer costs "by as much as $1,700" in the first year.
To counter that argument, exporters and pro-BAT groups say border adjustments would cause the U.S. dollar to strengthen over time. A stronger dollar would lower the cost of imports, helping to offset the effects of the tax.
Well, that's the theory. A border adjusted tax of the type House leaders envision has never been put to the test in the real world. Importers say they haven't seen much benefit from a stronger dollar in the past. "If I see any price reduction due to a stronger dollar, it is a minor miracle, and it will probably take a year or more of arguing with my suppliers," says Don Chernoff, founder of SkyRoll Luggage Co., a Reston, Va.-based company that imports its luggage from Thailand. "In the end I get mostly zero benefit from a stronger dollar. The academic economists never seem to understand any of this reality."
One such economist, Alan Auerbach of the University of California at Berkeley, argues that by focusing on the interplay of imports and exports, BAT critics miss the point. Border adjustments, he says, will boost domestic production while reducing incentives for companies to shift profits overseas, where they're untaxed by the U.S. until brought home.
Companies are taking their message to consumers. In late February the National Retail Federation, which opposes the BAT, started airing TV commercials that parody an OxiClean infomercial, telling shoppers that "the all-new BAT tax is specially designed to make your disposable income—disappear!" Proponents, through the American Made Coalition that includes Johnson & Johnson and Pfizer Inc., launched a Twitter feed to support the tax. Both sides have created Facebook pages and websites with auto-form letters that viewers can send to Congress. Both, too, routinely pepper media outlets with press releases citing prominent people in the private sector and academia who either love or hate it.
The politics are no less complicated. Texas Representative Kevin Brady, the Republican chairman of the tax-writing House Ways and Means Committee, has been on a media blitz since the start of the year to sell the concept to the public and fellow lawmakers. So far he's struggling. A core group of House Republicans has come out in recent weeks against the BAT, citing the higher prices they'd inflict on consumers. Republican Senate support is in doubt, too. Tom Cotton, a Republican from Walmart's home state of Arkansas, told a Senate floor session on Feb. 15 that border adjustments are "a theory wrapped in speculation inside a guess." The next day, Senate Majority Whip John Cornyn, a Texas Republican, said, "The hard reality is the border tax is on life support."
The big question is where Trump stands on Ryan's plan. Senior advisers seem split: Trump's chief strategist, Steve Bannon, is an enthusiastic supporter of border adjustments, while National Economic Council director Gary Cohn and Treasury Secretary Steve Mnuchin are said to be against them. In a Bloomberg TV interview on March 8, Commerce Secretary Wilbur Ross indicated he's still on the fence. "As we get to understand more of the intricate details of it ... that's when we will take a position," he said.
Ryan and Brady aren't backing down. Without border adjustments, they say, their plan to rewrite the tax code can't happen. That $1.1 trillion in revenue is crucial to the politics of the BAT, since it helps keep it deficit-neutral, a prerequisite for passing a tax bill through the Senate without Democratic votes. "What it boils down to is that it's a way to pay for the rest of the tax plan," says Veronique de Rugy, an economist at George Mason University. "Only revenue comes from this feature—economic growth doesn't." That $1 trillion is also crucial to how the BAT might affect the economy. Says Ross, "That is way too big a number to get wrong."
—With Sahil Kapur
The bottom line: A border adjusted tax would cut the 35 percent corporate rate to 20 percent but tax imports, leaving clear winners and losers.