Policy expert Caroline Freund weighs is on the short- and long-run effects of the GOP’s border adjustment plan.
By Dwyer Gunn
(Photo: Mario Tama/Getty Images)
At a lengthy press conference yesterday, President Donald Trump promised to unveil a comprehensive tax reform package in early or mid-March. While the administration has been a bit vague about its tax reform preferences, the GOP actually does have a detailed blueprint for reform — it’s based on the “A Better Way” proposal released last year.
That blueprint calls for a number of changes: big cuts to tax rates for both individuals and businesses, the elimination of most itemized deductions for individuals, and measures to encourage big capital investments by companies (while discouraging debt financing). The plan also calls for a pretty dramatic change to how the United States taxes corporations. Under the current system, U.S. companies are taxed on their profits, regardless of where those profits are earned; the GOP wants the country to shift to what’s called a “destination-based cash flow tax system,” in which corporate taxes are border-adjusted. Under the blueprint’s corporate tax border adjustment plan, revenues earned from sales outside the U.S. would no longer be subject to taxation, but companies would not be able to deduct the cost of imports from their tax bills. (The Tax Foundation has severalexcellent explainers on the GOP’s tax reform plan.)
To find out more about how the GOP’s border adjustment plan would work, and how it might affect low- and middle-income Americans, we spoke with Caroline Freund, an economist at the Peterson Institution for International Economics.
Why do some people think the border adjustment plan would be a better tax system for the U.S.?
We have a problem now where companies are shifting headquarters to other lower tax nations, like the Bahamas or Ireland, so that they can save on their U.S. tax bill. And, as a result, we’re losing that share of revenue. And, to some extent, the production and jobs that might go with having those businesses in the U.S.
Despite those advantages, some companies and industries are not supportive of a border adjustment plan. What are the industries that would possibly be hurt by this, at least in the short term?
Well, just going back one step, the way [the GOP is talking about]doing it is a bit strange. In the sense that imports would be taxed at the full rate of the business tax, which the proposed amount is 20 percent, and exports wouldn’t be taxed at all. The idea is that any revenues you have from any other part of the world just aren’t taxed, so you don’t have to worry about trying to transfer incomes around and stuff. And imports don’t get discounted, so there’s no reason for you to overstate your import bill to reduce your corporate profit. That’s the reason it works to solve this gaming of the tax system.
Caroline Freund. (Photo: Peterson Institute for International Economics)
On the other hand, for companies that rely on imports for their sales, they can no longer deduct it. Retailers like Walmart or Target wouldn’t be able to deduct from their profits the amount they spent to buy all the goods that you see for sale in their stores, so their tax bill would just go up enormously. The same is true for firms, like some of the auto companies, that use a lot of imported inputs — because they wouldn’t just be taxed on the profits from the car, they’d be taxed on the profits plus the cost of imports, so a lot of the industries that are dependent on imports are lining up against the proposal.
And in the short term, how would a system like this affect lower- and middle-income Americans?
It would probably hurt them because now some of this tax is going to pass into prices. Especially goods that are imported or have a high import content—those goods are going to be more expensive. And poor people tend to spend a larger share of their income on consumption so they’re going to be the most affected, and negatively affected.
That to me is the biggest concern: that we’re going from a tax that largely hits wealthy shareholders … to something that’s more of a tax on consumption.
What do advocates of this change say will happen over the long term to low- and middle-income Americans?
Over a longer time frame, what would happen is both prices and wages would rise in lockstep. Or, alternatively — and it could happen either way — the nominal exchange rate would adjust and completely offset the tax.
You can do it either through prices and wages, or through the nominal exchange rate, or through some combination. Once that happens, there should be no real competitiveness effects. If you just think of it in terms of the nominal exchange rate, although there’s this tax on the good that’s imported, the exchange rate is stronger so those goods were cheaper in dollars. It’s all a wash. Or in terms of prices and wages — yeah, the price went up by 28 percent, but my wage went up as well, so I can buy the same amount of goods.
Is there any reason to be skeptical, or concerned, about whether these adjustments are going to happen?
Yeah, I think so. What you often hear about this tax is “Oh, well, other countries do it with their value-added tax, which are basically sales taxes.” And, in fact, when you look at what happens — the real exchange rate values on average seem to kind of offset it.
I think the difference here is, because different goods are being treated differently, it’s just not clear what the mechanism by which it’s going to happen and be transmitted through the economy is. And, as a result, it could be quite a long period where, say, prices have gone up but wages haven’t.
I do believe if we were to do this tax system … in the long run, this aspect of it would disappear … but I think there’s a real question how long that long-run is: whether it’s one year, two years, five years.
And anyone who says it will happen immediately is saying that from pure faith in theoretical models. They’re not saying that from data.
Do you think this change is actually going to happen?
That’s the $64,000 question! I actually don’t think it’s going to happen. Or certainly not in its current form anyway.
I think there are a lot of industries lining up against it. The administration’s going to be very concerned about a sudden and large rise in prices that’s not going to make them popular.
I don’t think, in its current form, it’s going to happen.
I think what that means is one of two possibilities. One is a watered-down version of this with a really long transition. I think there’s a possibility of excluding sectors, though, in my mind, that makes it even worse. And then the other possibility, which I think is the more likely one, is they end up just going for a more standard corporate income tax cut of something like 7 percentage points, so much less bold reform, which has a better likelihood of being able to be done quickly and get through both the House and the Senate. Currently, the House can pass this proposal … the Senate can’t right now.
And the administration hasn’t jumped on board. If the administration were to jump on board, then I think it would be very different. But they’ve so far been kind of lukewarm on it.
This interview has been edited for length and clarity.
