Is the Border Adjustment Tax Really a Threat?
About a month ago, prior to President Trump’s inauguration, I wrote an article on Border Adjustments and Tax Reforms. My objective was to provide a condensed view of the details, without stating my opinion, if reforms would actually get ratified.
I have decided to revisit the border tax adjustment proposal, its impact on the US economy, and the apparel and footwear sector.
I want to begin with a relevant point that is frequently overlooked – while a border tax would be new to the United States, most of the world, including Europe has a value-added tax (VAT), that has similar features. With value-added taxation, a company does not pay VAT on what is imported because it receives a VAT refund, or offset on what it exports. However, the difference is that both imports and domestically produced items pay the same VAT.
But Don’t We Have Import Tariffs Already?
The US has had a tariff program since the Tariff Act of 1789. The goal of using higher tariffs to promote industrialization was urged by the first Secretary of the Treasury, Alexander Hamilton. The U.S. Constitution gives the federal government authority to tax, stating that Congress has the power to lay and collect taxes, duties, imports and excises, pay the debts and provide for the common defense and general welfare of the United States, as well as regulate Commerce with foreign nations.
Tariffs were the largest source of federal revenue until the federal income tax began after 1913. For well over a century the federal government was largely financed by import taxes, which averaged about 20% of the value.
Today, duty rates in the U.S. can be ad valorem (as a percentage of value), or specific (dollars/cents per unit). Duty rates vary from 0% to 37.5%, with the average duty rate being 5.63%. Some goods are not subject to duty. (Some electronic products)
Tariffs are intended to give domestic products a price advantage by making their foreign competition more expensive.
However, the United States is largely a free-trade country with open markets, and some of the lowest tariffs within the WTO, and the world. China, Japan, Brazil and many other trading partners are protectionist countries with semi-closed markets. Of all imports into the United States, 54% are duty free while 46% of all imports are taxed.
Examples of Import Tariffs:
Clothes made of cotton - 16% tariff
Clothes made of synthetic -32% tariff
Footwear – all over the board, but 20% tariff on average
Most vegetables -20% tariff
Apricot, cantaloupe, and dates -29.8% tariff
Most auto parts -25% tariff
Canned tuna -35% tariff
The member countries of the WTO tend to have the lowest average tariffs. By comparison, the average import tariff is 17.6%, but only 1.4% for the United States. However, countries such as Vietnam apply deep taxation on U.S. products, such as a 70% tariff on U.S. made cars, and a 50% tariff on American machinery.
If the world is moving toward free trade, why are there import tariffs at all?
Emerging countries tend to have a more aggressive tariff schedule. Nevertheless, here are some of the major reasons import tariffs are used:
Protecting domestic employment
To protect up-and-coming industries
Across all foreign goods the average U.S. tariff placed on imports is 1.4%
Updating the U.S. tax system has become a unifying principle of the leadership in Congress and the Trump Administration. Just about everybody agrees that the current system is burdensome, complicated and antiquated.
The proposal’s architects of Border Adjustments and Tax Reforms have been House Ways and Means Committee Chairman Kevin Brady (R., Texas), and Speaker Paul Ryan (R., Wis.). The overarching objective is to remove disadvantages created by other countries’ tax systems and to enable U.S. companies to be internationally competitive.
They have support among House Republicans, and major export-driven companies such as General Electric. Supporters say the House tax plan would encourage domestic investment, and reward companies that manufacture in America. Recently, GE, Dow Chemical and Pfizer joined a coalition backing border adjustment that says the proposal would improve competitiveness for American-made products.
Meanwhile, Wal-Mart, Target, Nike and Toyota joined an opposing coalition, warning that border taxes could cause consumer prices to increase.
A border-adjusted tax would impose a tariff on imports, including raw materials and components used in manufacturing, and exempt exports altogether. Under the proposal, companies will not be able to deduct the cost of goods sold (COGS) from their income taxes when the costs are imported. However, U.S corporate taxes could drop 15% from the lofty current mark of 35% to a more competitive 20%. All revenue associated with exports will be entirely exempt from taxation.
A sampling of Global Corporate Tax rates:
United States – 35%
United Kingdom 20%
Hong Kong 16.5%
A border tax would impact various industries, such as the US energy sector. Import refineries will face taxes that they do not have today, thus US refineries will be competing on a level playing field.
Interesting to note that the top 2 imported products by US are:
Petroleum oils worth US$ 132,595,566 million.
Automobiles worth US$ 98,625,996 million.
Are additional border adjustments or import tariffs coming?
In numerous interviews, President Trump has called Border Adjustments "too complicated." His leadership team has placed less emphasis on the use of tariffs, describing them as a tool to be used to initiate discussions on trade and security with our trading partners around the world.
“Any time I hear ‘border adjustment,’ I don’t love it,” President Trump said in a Jan. 13 interview with The Wall Street Journal.
Furthermore, Wilbur Ross, Trump's nominee for commerce secretary, is opposed to border tax. He stated that lowering the corporate tax rate is the biggest single tool that we could use.
Therefore, I believe that we are not going to see additional border taxes or a “destination tax”. The dialogue and conversations will continue, but tax reform will develop with different measures and policies.
Import tariffs for our industry are equally unlikely. In 2015, the U.S. government collected about $14.5 billion on apparel and footwear imports, approximately 42 percent of all duties collected by the U.S. government. With this stated, I cannot see changes coming to the current model that will impose additional tariffs on the apparel & footwear sector.