Why the Border Tax Needs to Die Now

The centerpiece of the House Republican tax reform plan is a border-adjustment tax (BAT) that would tax all imports and exempt all exports. The revenue generated from this new tax would be used to fund a reduction in the corporate income tax.

Supporters of the BAT tax contend that it levels the playing since many countries already exempt their own exports and tax import via the value-added tax, but Dan Mitchell and Veronique de Rugy dispel that myth in a recent Wall Street Journal piece.

The plan calls for dropping the top corporate tax rate to 20% from 35%, while exempting exports and taxing imports. House Republicans have latched onto the border-adjustment tax for a very practical and understandable reason. It supposedly would generate more than $1 trillion of tax revenue over 10 years. That money could finance other parts of their agenda to generate growth, such as replacing today’s onerous depreciation rules with immediate expensing….

Proponents of the border-adjustment tax also are using a dodgy sales pitch, saying that their plan will get rid of a “Made in America Tax.” The claim is that VATs give foreign companies an advantage. Say a German company exports a product to the U.S. It doesn’t pay the American corporate income tax, and it receives a rebate on its German VAT payments. But an American company exporting to Germany has to pay both—it’s subject to the U.S. corporate income tax and then pays the German VAT on the product when it is sold.

Sounds horribly unfair, right? Don’t be fooled. Like magicians, those making this argument are distracting the unwary, hoping that nobody will notice the trick.

Here’s the real story: What matters from a competitive perspective is whether the playing field is level—and it is. When the German company sells to customers in the U.S., it is subject to the German corporate income tax. The competing American firm selling domestically pays the U.S. corporate income tax. Neither is hit with a VAT. In other words, a level playing field.

What if an American company sells to a customer in Germany? The U.S. government imposes the corporate income tax and the German government imposes a VAT. But guess what? The German competitor selling domestically is hit by the German corporate income tax and the German VAT. That’s another level playing field. This explains why economists, on the right and left, repeatedly have debunked the idea that countries use VATs to boost their exports.

Companies can be disadvantaged, though, if their country’s tax regime is onerous. One big plus for Americans is that Washington does not impose a VAT, which would enable government to grow. This is a major reason that the U.S. economy is more vibrant than Europe’s. In Germany, the VAT raises so much tax revenue that the government consumes 44% of gross domestic product—compared with 38% in America.

The BAT is far too complex, it is a loser both economically and politically, and maybe most importantly it provides the federal government with yet another lever to raise taxes over time.