A central theme of President Trump’s 2016 campaign was that international-trade and tax policies can discourage companies from creating jobs in the U.S. Trump feels so strongly about this that he has contemplated implementing a “border tax” in the early days of his administration. While skepticism of trade in general is unwarranted, there’s an element of truth to the idea that American manufacturers can’t compete on an un-level playing field. The tax proposal spearheaded by Ways and Means chairman Kevin Brady and championed by his fellow House Republicans would be a great way to correct the problem, and may be just the international business-tax policy that President Trump is looking for.
The current U.S. corporate-income tax is “origin-based,” which means it taxes companies based on the location of their production. It is the highest such tax in the developed world, as Tax Foundation research shows. In a political environment that has focused so much on bringing jobs back to the United States, this origin-based system is due for a change. It makes little sense to make our corporate-tax system origin-based if we want to encourage new investments in our country. This is why Chairman Brady has taken to calling the current corporate-income tax the “Made in America” tax. It is also why other countries have slashed their origin-based taxes and left the U.S. behind.
Experts have long agreed that our business-tax system makes little sense, and they have developed a few alternative proposals under which businesses would still pay a share of taxes but wouldn’t be penalized for investing in new U.S. jobs. The most commonly proposed alternatives are a “destination-based” system in which businesses pay based on where their revenues are earned, and a “shareholder” system in which business owners pay based on where they live. Both of these approaches are largely superior to the current system.
Chairman Brady’s proposal would make the U.S. corporate-income tax destination-based rather than origin-based, using a tool known as a “border adjustment.” This is a good trade. It would prevent companies from avoiding U.S. tax liability by locating their production abroad. In his own talk of “border taxes,” Trump has intuited the problem Brady means to address. “A company that wants to fire all of its people in the United States and build some factory someplace else and then thinks that that product is going to just flow across the border, that’s not going to happen,” he recently told a group of top American CEOs.
A destination-based tax perfectly fits Trump’s aims. It would also be a comprehensive solution.
A destination-based tax perfectly fits Trump’s aims. It would also be a comprehensive solution, and therefore far better than using individual penalties on individual companies or putting up a pure tariff, which would damage the tradable sector of our economy unnecessarily by discriminating against it. (Layering a tariff on top of the current system would essentially tax the tradable sector twice and everyone else only once.)
This is not to say that a destination-based proposal has no drawbacks; for one thing, if it were the only component of the plan, it would be a tax increase. But House Republicans plan on using it to help make other tax cuts even larger than they were before.
In a piece last week for National Review, John McLaughlin and Jim McLaughlin criticized the border-adjustment approach and cited their own polling data to suggest that it is unpopular with the public. But neither their words nor their poll questions really captured the current policy situation and the tradeoffs being made here. They seem, for example, to be under the misapprehension that President Trump does not want any border taxes, when he has said repeatedly that he favors them. Furthermore, their polling is based on the premise that a border adjustment would be a “new” tax, rather than a modification of an existing tax that already penalizes Americans. Despite this characterization, an astounding 41 percent of those polled still approved of the idea. One wonders how high that number would be if respondents were given additional information about the tax cuts the proposal would help pay for.
It seems as though a large number of Americans really do think businesses that locate production abroad and sell in the U.S. should pay tax on that activity. In this, they appear to agree with President Trump. And a proper, vetted, destination-based system combined with offsetting tax cuts is the best way for them to realize their vision. Chairman Brady’s border-adjustment proposal may, in fact, be just the thing Trump is looking for.