Phasing in the Border-Adjustment Tax Won’t Solve Its Problems

by Veronique de Rugy

I wish we could stop talking about the border-adjustment tax. Unfortunately, I can’t — because Speaker Paul Ryan and Ways and Means chairman Kevin Brady remain committed to it. That’s even after plenty of evidence that a tax proposal with the BAT in it won’t pass the Senate. It may not even pass the House. That’s also after the White House has expressed its skepticism about the proposal repeatedly.

As a result, we can’t stop talking about the import-tax-plus-export-subsidy proposal and we are not uniting behind a tax-reform plan.

The fight of the day, as you know, is about whether the border-adjustment tax would be acceptable if phased in over five years. Another way to ask the question is: Can you make a bad tax policy better by introducing it slowly? The answer is pretty clearly no.

I have written about this here and here. First, phasing in the BAT would make it even less likely to win the White House over because it would increase the trade deficit in the short run and it would make the currency adjustments more “rocky” (for lack of a better word). The phasing in of the tax means that you are also phasing in the currency adjustments. That would maybe work, if markets weren’t forward-looking — but they are. The result would be a hot mess with currencies adjusting today as a result of the anticipations of future appreciations and higher trade deficits for years. Now some of those effects will go away over time, but the final outcome is probably that currencies won’t fully adjustment when all is said and done.

This excellent post by AEI’s Stan Veuger details how this works in a much better way than I can. The whole thing is a must-read but he concludes:

This means that the prices of imports will be significantly higher during the phase-in period than they would have been in the absence of the policy change, but not as high as they would be if the dollar appreciated by enough to fully offset the ultimate border adjustment. After implementation, the prices of imports will be slightly higher than they would be under a fully offsetting dollar appreciation, while the prices of exports will be slightly lower. Together, these relative price shifts generate larger trade deficits early on, and smaller ones starting in 2022 or 2023.

In other words, it is not a good idea.

Finally, I have suggested before that border-adjusting our corporate-income tax presents massive implementation challenges. In particular, it would be a nightmare for a bunch of industries such as the financial and insurance industries. But here is the thing: If you propose a separate track for these services, you complicate rather than simplify the tax code. In particular, if you exempt the financial industry from the destination-based tax, you can kiss goodbye the argument that the BAT is great precisely because it addresses transfer-pricing issues. (I personally find the argument that the BAT is undermining tax competition disturbing and even shocking when made by people who supposedly care about smaller government.)

Well, sure enough, that’s what Chairman Brady wants to do now. According to the Wall Street Journal:

Mr. Brady also said his plan would include targeted rules for the financial services, insurance, communications and digital-services industries.

As Chris Edwards noted, “That’s a big share of the economy! So border adjustment — which is supposed to simplify transfer pricing — will apparently need a large array of specific-industry rules in order to work. Tax reform is supposed to simplify the code, but such rules will make it more complex. And Chairman Brady left out other industries that would probably need special cross-border rules, like airlines and international shipping.”

And yet, as the Wal Street Journal’s Richard Rubin and Siobhan Hughes remind us, Speaker Ryan “is not budging.”

The Corner

The one and only.