Making Tax Reform Deficit Neutral Without a Border Adjustment Tax: Part 1 (article)

The tax plan recently unveiled by the Trump administration raises questions about whether deficit spending will be used to pay for tax reform. Various proposals have emerged to provide for revenue raisers that could offset the costs of tax cuts associated with tax reform. An examination of these proposals will help to contrast the substance and merit of each as a potential piece in the overall tax reform plan. In a two-part series, we will explore a brief outline of each proposal, highlight who created or championed each one, and include some concerns raised for each.

Our focus will be on alternatives to the Border-Adjusted Tax (BAT) that contain the structural components necessary to accommodate tax cuts without increasing the deficit. These alternatives are relevant because it is not clear that the BAT has meaningful support within the White House or the Senate. While less aggressive forms of tax rate cuts could achieve a similar objective, this notion will not be explored since the stipulated tax rate cuts appear to be a given in any Republican tax plan. As Representative Tom Cole (R-OK) said, “God made Republicans to cut taxes. That's what they do. And they don't worry too much about the budgetary consequences of it sometimes.”

Each installment of our two-part series will cover three proposals, which are addressed in no particular order.

Tariffs and Reciprocal Taxes

Who is proposing it?
President Trump has referenced both tariffs and reciprocal taxes in numerous comments and speeches.

What is it?
In this case the President appears to be speaking of an import tariff, which is a tax on goods imported into the country. The reciprocal tax appears to be an offshoot of this, where the tariff is increased or reduced depending on how a particular foreign country taxes U.S. goods.

How does it work?
The concept of a tariff is rather simple. Each item imported into the country is taxed at a set rate. Mechanically, a tariff can be quite complex. For instance, imported goods are taxed at varying rates, so categories must be defined and applied to each good to determine the correct rate. A recent court case involving Allstar Marketing Group, LLC (owner of the Snuggie® brand) shows the importance and difficulty of these categories. In this case, the Court of International Trade was asked to determine whether the good imported was a blanket, or whether the presence of sleeves made it an article of clothing. At stake was a 6.4 percent tax rate difference between blankets and clothing. In the end the court ruled that classification as a blanket was appropriate, and the result led to an estimated $16 million dollar refund for Allstar Marketing Group, LLC.

Additionally, tariffs can also vary depending on the jurisdiction from which an item is imported, and can be limited or eliminated in certain instances under free trade agreements such as NAFTA. Tariffs are frequently used to protect domestic industries or to punish foreign producers. The reciprocal tax appears to be a carrot to the tariff’s stick. The idea appears to be that a particular tariff would be reduced or eliminated if the foreign country reduced or eliminated its tax on a corresponding item. These agreements would be negotiated on a bilateral basis.

How much money will it raise?
It depends on numerous factors. President Trump briefly suggested a 20 percent tariff on products imported from Mexico to pay for a border wall, which was estimated to raise $16-$25 billion. However, the extent of the revenue raised would depend heavily depend on the tariff rates, items taxed, and any reciprocal agreements.

Much like a value-added tax, tariffs are criticized for being regressive. For instance, a tariff is often added to the final price of a good, and where imported goods from countries such as China are involved, such goods are disproportionately consumed by lower income individuals. Additionally, the World Trade Organization (WTO) generally finds that tariffs violate international trade agreements, under which tariffs are generally restricted. Penalties for such violations can be fines or retaliation in the form of additional tariffs. Opponents of tariffs argue that if the U.S. is not compliant under the WTO, then other countries are not incentivized to be compliant, which would create barriers to trade and reduced economic efficiency.

Sales Factor Apportionment

Who is proposing it?
Academics and economists, including members of the Roosevelt Institute and consultants at the District Economics Group.

What is it?
A corporate profits tax using an allocation methodology borrowed from sales tax.    

How does it work?
The simplified version is that a multi-national corporation’s profits would be taxed in each jurisdiction based on the share of global sales generated within each jurisdiction. Like the BAT, this would be a major shift to a territorial tax system and away from the current system of taxing businesses on their worldwide income. For example, if 10 percent of a corporation’s global sales were from one country, then 10 percent of its profits would be taxable by that country. Proponents note that a company cannot shift profits to low-tax countries in order to minimize tax obligations, because it cannot shift its customers from one country to another. They also posit that corporate tax compliance will be simplified, because complicated structures designed to shift profits to low-tax jurisdictions will become obsolete.

How much money could it raise?
One report projects that it could increase revenues by as much as 169 percent, but if combined with tax rate cuts, the report projects that it will be revenue neutral.

The difficulty the states have in applying existing sales and use tax provisions to online retailers such as Amazon may be a harbinger of an imperiled administration for this proposal. Sourcing rules undoubtedly would become highly complex, as they are in the U.S. sales tax arena. Additionally, profit shifting still can occur through the use of intermediaries. For example, a multi-national business could sell a product to an intermediary that is in a low-tax jurisdiction. When the ultimate consumer is in a high-tax jurisdiction, this first sale to the intermediary could be set to yield most of the profit to the multi-national business, with the foregone profit being less than the tax savings obtained from the low-tax jurisdiction. The intermediary can then resell the product to the consumer for a small remainder of the total profit, which minimizes the reach of the high-tax jurisdiction on the transaction. If the intermediary is unrelated to the multi-national business, it would be very difficult to collapse the transaction, leaving the high-tax jurisdiction with little recourse to collect the lost revenue.

Value Added Tax (VAT)

Who is proposing it?
No one, though a Washington Post report indicated that the White House was considering such a tax. The White House quickly disputed the report.

What is it?
A VAT is similar to a sales tax, but is applied primarily to transactions throughout the supply and sales chain through a series of incremental taxes at each stage.

How does it work?
Each transaction along the supply chain is taxed. For example, a company that purchases cattle to make leather would incur a tax on the purchase from the supplier. If the company then sells the leather to a sewing shop that uses the leather to make seats for a car, there is another tax incurred by the sewing shop. When the sewing shop sells the seat to the car maker, there is yet another tax incurred by the car maker. These taxes are added to the final sale price of the car, passing them on to the consumer, but are actually paid at each step in the process. As with the BAT and other territorial tax systems, VATs reduce the incentives for corporate profit shifting. VATs are also said to do a better job of taxing economic output because they are a tax on consumption versus a tax on capital.

How much money will it raise?
Estimates indicate that a VAT would generate significant revenue, with some arguing that a 10 percent VAT would raise $750 billion per year.

Larry Summers, a veteran of two presidential administrations, has said of the VAT that ''Liberals think it's regressive and conservatives think it's a money machine.” The concept of a VAT is generally disliked on both ends of the ideological spectrum. A VAT is passed on to consumers through higher prices which disproportionately affects low-income individuals, resulting in opposition from liberal groups. On the other hand, the amount of money a VAT can raise is substantial, which conservatives argue leads to an expansion of government and steadily increasing tax rates. Additionally, a VAT carries with it (whether or not deserved) certain European stigmas that are disliked by many politicians.


Each of these proposals has its benefits and drawbacks along with supporters and detractors, but winners and losers will emerge with any large scale tax reform. The prospects for permanent tax reform and bipartisan support are sure to shape discussions concerning these proposals. After the demise of the American Health Care Act, the White House is asserting a greater presence in the tax reform process. This leaves an opening for any one of these proposals or for one that will be discussed in the next installment of this series.

For more information on tax reform, please contact your CBIZ MHM tax professional.

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