Why A Border-Adjusted Tax Would Hurt U.S. Companies

Why A Border-Adjusted Tax Would Hurt U.S. Companies

The U.S. corporate income tax system is awful and needs to be reformed, but it does not subsidize foreign imports or justify a border-adjusted tax.
Veronique de Rugy
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There are many bizarre and unsubstantiated claims about the merits of adopting a border adjustment tax (BAT) as part of a fundamental tax code reform, as House Republicans have proposed. For instance, we are told that taxing imports and exempting exports creates economic growth. However, estimates show that the boost to the economy comes from the overall plan’s other features like lowing the rates or moving to a territorial system, not from the BAT.

We are told that the BAT may be a tax on imports but it’s not protectionist since currencies will perfectly adjust to offset the penalty to importers and the benefits to exporters. That’s in spite of empirical evidence finding that currencies are unlikely to adjust perfectly or rapidly. We are told that we are the only country without a border tax. But no other country border adjusts their corporate income tax, only their consumption taxes.

However, no argument is more confusing to me than the one made in these pages by Scott Ruesterholz. He claims our tax code advantages foreign businesses or, as he puts it, “Without a border adjustment, U.S. tax code subsidizes international importers at the expense of domestic producers.” Now there is no doubt that the U.S. corporate income tax system is awful and needs to be reformed, but it is terribly wrong to say that it subsidizes foreign imports or justifies passing a BAT.

Other Countries Do Have Corporate Income Taxes

The good news is that, unlike many others, Ruesterholz seems to understand the difference between a value-added tax (VAT) and the corporate income tax. He also acknowledges the existence of both forms of taxation. Believe me, these days one must praise those who are honest enough to make the distinction. Many don’t.

He also correctly notes that a plane sold by Mexico and consumed in Mexico is faced with the same VAT as a plane sold by a U.S. exporter of planes to Mexico. From that perspective, he notes, “From Mexico’s side, it is treating the two plane producers fairly.” He is correct.

But then he starts going off the rails. He writes:

In reality, the U.S. plane exporter would have had to pay U.S. taxes on the profit from building the plane in the U.S. plus 16 percent to Mexico. Meanwhile, the Mexican producer just pays the 16 percent. By having to pay U.S. taxes in addition to all of the same Mexican taxes, it is relatively more expensive for the U.S. manufacturer to export into Mexico compared to Mexican companies. So while neither system on a stand-alone basis is unfair, their interplay leads to an unfair outcome for American exporters.

Come again? I assume he is saying that the U.S. exporter is treated unfairly because he has to pay the U.S. corporate tax and the Mexican VAT, while the Mexican producer only has to pay the VAT. If so, it’s bizarre considering that Mexico also has a corporate income tax. In other words, Ruesterholz is wrong to claim that only the U.S. exporter is subject to the corporate income tax.

He then continues:

Going the other way, let’s say the Mexican plane manufacturer assembled a plane in Mexico and exported it to the United States. As the VAT is essentially a sales tax and the final sale was not in Mexico, the Mexican government refunds any taxes collected along the way, and the U.S. assesses a tax on the difference between the final sales price and the import price. This means any profits earned from assembling the plane benefit from an artificially low tax rate given the lack of a Mexican VAT charged. Conversely, a domestic manufacturer has to pay U.S. income taxes on all the profits generated by the plane, from assembly to final sale. Once again, the American company pays more taxes than the Mexican company. This is the case for trade with every country that has a VAT—basically the whole world.

Oh boy. This paragraph makes me think Ruesterholz profoundly misunderstands how corporate taxes work. Or maybe it is that it too mixes consumption and income taxes. One thing is sure is that he seems to once again ignore the fact that the Mexican plane exporter to the United States has to pay a corporate income tax in Mexico. In that sense, it is subjected to the same kind of tax treatment as the U.S. plane producer selling its goods in the United States. Both of them will be taxed by the corporate income tax in their own country, and where the income was earned.

To be sure, the Mexican exporter won’t have to pay the consumption tax (VAT) on its export because the good isn’t consumed in Mexico. We do not have a VAT in America (thank God!) so neither the U.S. producer or the Mexican exporter selling in the United States has to pay it. That’s fair. In other words, the fact that the Mexican exporter isn’t paying the VAT in his own country when it sells a good consumed abroad doesn’t give him an advantage.

Actually, the Playing Field Is Level Across Borders

Here is a summary that should help you understand that there is actually a level playing field:

Sold and competing in U.S. MarketSold and competing in Mexico Market
U.S. planeU.S. corporate income taxU.S. corporate income tax, Mexican VAT
Mexican planeMexican corporate income taxMexican corporate income tax, Mexican VAT

When people are railing about other countries’ VATs and the rebate foreign exporters get at the border, I always wonder how they feel about the fact that the United States doesn’t have a VAT. It means that there is nothing to rebate at the border.

Doesn’t Ruesterholz think it is unfair to other countries? After all, if it is unfair for the Mexican government to rebate the VAT at the border, it may seem unfair that the United States doesn’t have a VAT at all. Would Ruesterholz wish we had a VAT so we could rebate it at the border like other countries do, while our non-exporting companies would be hammered by the levy, similar to how other countries punish their non-exporting companies? I, for one, am grateful that U.S. domestic companies and exporters don’t have to deal with a VAT.

Based on this incoherent example, Ruesterholz concludes:

This system makes it relatively difficult for a U.S. company to export to the rest of the world and relatively easy for the rest of the world to export to us. Quite simply, U.S. producers are subsidizing importers. As a consequence, Americans enjoy some artificially cheap imported goods, but fund it with lower export-related employment.

Now that’s painful since, as we have established, Mexican goods sold in the United States are not getting any special tax advantage. Also, U.S. goods sold in Mexico are subjected to the same treatment as Mexican goods sold in Mexico (see table above). Also, U.S. goods sold in Mexico are treated the same as French, German, or any other country’s goods sold in Mexico. The bottom line is that we are not subsidizing foreign imports, nor does “the system” make it harder for us to export to the rest of the world.

Actually, A Border-Adjusted Tax Would Be Unfair

This brings me to the final nonsense in this piece. That’s the idea that whatever disadvantage exists with our system needs to be addressed with a border tax on imports and an exemption on exports. He writes: “Third, we can apply a border adjustment to balance the competing systems back into equilibrium. That strikes me as the best choice.”

Hum … no. Under this scenario, the Mexican company exporting to the United States would now pay the Mexican corporate income tax plus a 20 percent border tax in the United States. Meanwhile, our domestic companies would only pay the corporate income tax.

In addition, U.S. exporters would pay no tax on their exports (since the corporate tax would be rebated at the border) and pay the Mexican VAT in Mexico. However, in Mexico, they would compete with Mexican companies paying both the corporate tax and the VAT. Imagine how well that’s going to fly with the World Trade Organization. I will tell you right now: not well.

European countries and others have already told the United States that we will face a WTO challenge as soon as the border tax is introduced, because it messes up the playing field. Looking down the road, the easiest way to respond to the WTO challenge is to switch from a BAT to a VAT. I don’t wish that on the United States.

For all the (fake) outrage about biases against U.S. companies and in favor of foreign imports, Ruesterholz totally omits the real penalties U.S. companies face: First, there is the super-punishing U.S. corporate income tax rate of 35 percent—the highest of all OECD countries. Mexico’s rate is 30 percent.

Second, unlike most of our competitors, U.S. multinationals are taxed on a worldwide basis and subjected to the very high corporate income tax rate if they bring their money back home. These penalties are creating a true disadvantage to U.S. companies (exporters, non-exporters, and multinational alike). The saddest thing is that it is self-inflicted and imposed by our own government.

The good news is that all Uncle Sam needs to do to fix the problem is to lower our tax rate to 20 percent or lower. Not need to implement a BAT to do that.

Veronique de Rugy is a senior research fellow at the Mercatus Center at George Mason University and a nationally syndicated columnist.

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