Why Trump Needs the Border Tax to Secure Across-the-Board Tax Reform

President Trump wants tax reform. The American people want tax reform. American companies want tax reform. Investors and markets want tax reform. Democrats? They don’t want anything Mr. Trump wants. Period.

That’s why policymakers, led by Paul Ryan, have settled on the border adjustment tax (BAT). It’s the only way Republicans in Congress can overhaul our Byzantine tax system through the budget reconciliation process. And that cumbersome approach is the only path available to the GOP, given that they lack 60 votes in the Senate.

Under reconciliation, the proposal must be revenue neutral over the ten-year budget window and thereafter. Since the evolving plan includes sharp reductions in personal and corporate rates, among many other changes, there is substantial lost revenue – and the only vehicle available to make that up is the border adjustment tax.

There are many proposed changes to both personal and corporate taxes in the plan coming out of the House. Here we focus on changing the way corporations are taxed, and on the merits of the border adjustment tax.

Levying a new tax may seem complicated – this revamp after all is supposed to simplify our tax code – but compared to the 75,000 pages of our current tax rules, adopting the new approach would be like reading Dick and Jane after a semester of Ulysses. Numerous deductions disappear and the plan adopts territorial taxation, used by most other countries – which eliminates the unproductive stockpiling of earnings overseas. Most important, the corporate rate drops from 35% to 20%.

What makes it all work is the 20% border adjustment tax, which raises more than a trillion dollars over a decade.

President Trump has sent mixed signals about his support for the BAT, and there appears to be some division amongst his White House staff. Most recently Steve Bannon threw his considerable weight behind the plan, joining other influential figures like Commerce Secretary Wilbur Ross and Chief of Staff Reince Priebus.

National Economic Council director Gary Cohn and Treasury Secretary Steve Mnuchin are said to oppose the tax, but some feel these relative newcomers to tax minutia will soon realize that the scheme drafted by Paul Ryan and others is the only possible way to meet the criteria set out by Congress’ own budget rules. Several groups have worked on tax policy for nearly a decade; if there were an easier approach, they would have found it.

For instance, many might think that revenues lost to dropping the corporate rate could be recaptured simply by eliminating the numerous tax breaks that companies currently enjoy. Our stated tax rate for companies is 39.1 percent, compared to an OECD average of 24.1 percent, one of the highest in the world. Our effective corporate rate – what companies actually pay on average after taking advantage of various deductions – is 27.9 percent, also one of the highest globally.

So why would slicing the rate to 20 percent be so tough? The problem is that most companies pay the lower rate mainly because they earn so much money overseas. It’s not because of depletion allowances or because of investment tax credits; it’s because Apple, for instance, earns more than two-thirds of its income overseas and pays taxes on those earnings at very low rates. Further, like many large companies, Apple keeps its foreign-earned cash overseas. Our government has no authority under current law to tax overseas operations until the money is brought home.

The border adjustment tax is like the Value Added Tax employed by 167 countries around the world. The idea is to tax goods coming into the country but not those flowing out. In effect, our government would reward exporters and penalize importers. In Europe, in part to attract investment and encourage exports, governments have lowered corporate income tax rates in recent years but made up for lost revenues by hiking their VATs.

As a consequence, companies making goods domestically in Germany, for instance, pay a 15 percent corporate tax rate (local fees add substantially to the total) but the federal government recoups revenues lost to that low rate through a 19 percent VAT on all domestic sales. The 19 percent levy on goods sold overseas is refunded, giving German exporters a significant competitive advantage.

There are already companies lining up to endorse and also to oppose the border adjustment tax. A group called the American Made Coalition, which includes exporters like GE, Boeing, and Pfizer, are in favor of the measure while Americans for Affordable Products – retailers like Walmart and others that depend heavily on imports – are dead set against it. The latter group says prices will rise, hurting consumers and the economy.

Some economists, like Martin Feldstein, argue that any consumer price hikes caused by a border tax will quickly be resolved through currency realignments. Thus, the cost to Americans of goods made overseas but paid for in dollars will drop. That connect-the-dots seems too theoretical, and the timing too uncertain, to boost confidence in the plan.

It is more likely that there will be perceived winners and losers, at least in the short run. Consequently, pushing the proposed plan will be a heavy lift for Republicans in Congress, especially with the likes of Elizabeth Warren screeching about how it is a gift to the billionaire class and a scourge to working people.

But Trump can turn that around and argue that the border tax will create jobs for working people – the kind who helped elect him. He has fractured the age-old alliance between labor and Democrats; last year he earned more union votes than any Republican since Reagan, by pushing a growth and jobs agenda. Trump needs to enlist union leaders to sell his tax overhaul to the country and to skeptical members of Congress.

He will ask Americans: are you willing to pay slightly more for your made-in-China t-shirts in order to put more people to work? At the same time, labor leaders will ask the 23 Democrat senators up for reelection in 2018, “Do you support tax reform that will bring manufacturing jobs back home and levels the playing field for American companies? Do you support Made in America” What can they say?

None of this will be easy, but if Trump wants to spur economic growth and job creation – the centerpiece of his campaign – driving through tax reform is essential. Sold the right way, Americans will climb aboard the Trump train.