By Semoon Chang
One reform among the many tax reform proposals made by President Donald Trump relates to corporate income tax. Currently, the corporate income tax rate of the U.S. is near the highest in the entire world, prompting U.S. multi-national companies to keep their profits overseas and even relocate their headquarters to other countries.
So far, two proposals are on the table. One is the Trump Tax Plans announced on April 26. 2017, and the other is the GOP (Republican Party) 2016 Policy Paper. The Trump plan proposes a cut in the corporate income tax rate from 35 percent to 15 percent and a territorial tax system, while the GOP plan proposes a cut in the rate from 35 percent to 20 percent and a border adjustment tax (BAT) system.
Since lowering the tax rate is straightforward, let us focus on the territorial tax and the BAT schemes.
Both the territorial tax and the border adjustment tax will not count export sales as taxable revenues. This means that profits from exports will no longer be taxable, providing a huge incentive for U.S. companies to increase exports.
No further details are provided regarding the territorial tax, including how to make up for the likely loss in tax revenue from the exemption of export sales from taxable revenue. Proponents of the territorial tax may be expecting their proposal to be the beginning of many serious discussions and changes before it is finalized. We thus introduce the GOP BAT which is the more thorough proposal.
The BAT is designed in large part to recover the loss in tax revenue from removing export sales from taxable revenue. Under the BAT, goods that are imported to the U.S., regardless of whether they are final consumption goods or inputs used to produce other final goods, are subject to 20 percent BAT, while goods produced in the U.S. and exported to other countries are not subject to the BAT.
Under the BAT, imported inputs can no longer be deducted as expenses, while exports are no longer counted as revenue for income tax purposes. Profits will be calculated as domestic sales from which domestic costs are subtracted. Accordingly, corporate profits will be higher as their exports increase and as they use more domestic inputs.
Here is the tricky part. The BAT will strengthen the value of the dollar from two sources. One is that the BAT of 20 percent on imports will lower demand for imported goods, which will lead to a decrease in the supply of dollars available in the global foreign exchange market. As supply decreases, the price, i.e., the value, of the dollar increases.
The other is that the removal of export sales from the exporters' taxable revenue will lower the cost of U.S. exports, which in turn lowers prices of U.S. exports. As prices of U.S. products are lowered in the global market, demand for U.S. products will increase, which will increase demand for U.S. dollars. This will also raise the price, i.e., the value, of the dollar in the global foreign exchange market.
According to proponents of the BAT, the policy will raise the value of the dollar by 25 percent. As the value of the dollar increases, prices of imports will be lowered enough to offset higher prices that will be caused by a BAT of 20 percent.
One benefit of the BAT to the U.S. economy is that U.S. companies will have less incentive to move to other countries since these companies will pay no income taxes when they export their products from the U.S. Another benefit is a decrease in the chronic U.S. trade deficit. Still another benefit is to lower tax avoidance since tax calculation becomes simpler.
Here are some problems with the BAT proposal.
First, the proposal effectively adds tariffs on imports to the U.S., and subsidies to U.S. exporters, which may lead to retaliatory tariffs by other countries. Secondly, if the increase in the value of the dollar falls short of the 25 percent, import prices will rise. If this were the case, the outcome would effectively be a subsidy to U.S. exporters by ordinary Americans who will be paying higher prices for imported products.
In the third place, rules of the World Trade Organization require imported goods to be treated the same as domestically-produced goods. The BAT may violate WTO rules and thus invite challenges from the U.S. trading partners. Fourthly, when the value of the U.S. dollar goes up, countries such as China with a large amount of foreign reserves in U.S. dollars will benefit, doing nothing.
Finally, U.S. retailers that heavily depend on imported goods will lose from the BAT, unless the value of the U.S. dollar rises quickly enough to offset the BAT of 20 percent. These include giant retail stores such as Wal-Mart, Target, Sears, Best Buy, Macy's, Dick's, Sports Academy and many more. It would be interesting to see how these problems will be resolved during the legislative process. On June 13, 2017, the U.S. House Ways and Means Committee chairman mentioned the possibility of a five-year phase-in for the BAT.
Chang Se-moon is the director of the Gulf Coast Center for Impact Studies. Write to him at: changsemoon@yahoo.com.
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So far, two proposals are on the table. One is the Trump Tax Plans announced on April 26. 2017, and the other is the GOP (Republican Party) 2016 Policy Paper. The Trump plan proposes a cut in the corporate income tax rate from 35 percent to 15 percent and a territorial tax system, while the GOP plan proposes a cut in the rate from 35 percent to 20 percent and a border adjustment tax (BAT) system.
Since lowering the tax rate is straightforward, let us focus on the territorial tax and the BAT schemes.
Both the territorial tax and the border adjustment tax will not count export sales as taxable revenues. This means that profits from exports will no longer be taxable, providing a huge incentive for U.S. companies to increase exports.
No further details are provided regarding the territorial tax, including how to make up for the likely loss in tax revenue from the exemption of export sales from taxable revenue. Proponents of the territorial tax may be expecting their proposal to be the beginning of many serious discussions and changes before it is finalized. We thus introduce the GOP BAT which is the more thorough proposal.
The BAT is designed in large part to recover the loss in tax revenue from removing export sales from taxable revenue. Under the BAT, goods that are imported to the U.S., regardless of whether they are final consumption goods or inputs used to produce other final goods, are subject to 20 percent BAT, while goods produced in the U.S. and exported to other countries are not subject to the BAT.
Under the BAT, imported inputs can no longer be deducted as expenses, while exports are no longer counted as revenue for income tax purposes. Profits will be calculated as domestic sales from which domestic costs are subtracted. Accordingly, corporate profits will be higher as their exports increase and as they use more domestic inputs.
Here is the tricky part. The BAT will strengthen the value of the dollar from two sources. One is that the BAT of 20 percent on imports will lower demand for imported goods, which will lead to a decrease in the supply of dollars available in the global foreign exchange market. As supply decreases, the price, i.e., the value, of the dollar increases.
The other is that the removal of export sales from the exporters' taxable revenue will lower the cost of U.S. exports, which in turn lowers prices of U.S. exports. As prices of U.S. products are lowered in the global market, demand for U.S. products will increase, which will increase demand for U.S. dollars. This will also raise the price, i.e., the value, of the dollar in the global foreign exchange market.
According to proponents of the BAT, the policy will raise the value of the dollar by 25 percent. As the value of the dollar increases, prices of imports will be lowered enough to offset higher prices that will be caused by a BAT of 20 percent.
One benefit of the BAT to the U.S. economy is that U.S. companies will have less incentive to move to other countries since these companies will pay no income taxes when they export their products from the U.S. Another benefit is a decrease in the chronic U.S. trade deficit. Still another benefit is to lower tax avoidance since tax calculation becomes simpler.
Here are some problems with the BAT proposal.
First, the proposal effectively adds tariffs on imports to the U.S., and subsidies to U.S. exporters, which may lead to retaliatory tariffs by other countries. Secondly, if the increase in the value of the dollar falls short of the 25 percent, import prices will rise. If this were the case, the outcome would effectively be a subsidy to U.S. exporters by ordinary Americans who will be paying higher prices for imported products.
In the third place, rules of the World Trade Organization require imported goods to be treated the same as domestically-produced goods. The BAT may violate WTO rules and thus invite challenges from the U.S. trading partners. Fourthly, when the value of the U.S. dollar goes up, countries such as China with a large amount of foreign reserves in U.S. dollars will benefit, doing nothing.
Finally, U.S. retailers that heavily depend on imported goods will lose from the BAT, unless the value of the U.S. dollar rises quickly enough to offset the BAT of 20 percent. These include giant retail stores such as Wal-Mart, Target, Sears, Best Buy, Macy's, Dick's, Sports Academy and many more. It would be interesting to see how these problems will be resolved during the legislative process. On June 13, 2017, the U.S. House Ways and Means Committee chairman mentioned the possibility of a five-year phase-in for the BAT.
Chang Se-moon is the director of the Gulf Coast Center for Impact Studies. Write to him at: changsemoon@yahoo.com.
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