It was recently reported in the media that the Trump administration had announced that it would seek to impose a 20 percent tax on imports, at least from countries with which the U.S. runs a trade deficit, as a means of funding the border wall with Mexico for which President Donald Trump campaigned. The reports were based on the following statement by Press Secretary Sean Spicer:
We have a new tax at $50 billion at 20 percent of imports – which is, by the way, a practice that 160 other countries do right now. Our country's policy is to tax exports and let imports flow freely in, which is ridiculous. But by doing it that way we can do $10 billion a year and easily pay for the wall. Just through that mechanism alone.
However, administration officials later clarified that the plan was merely “one of several options.” More importantly, it is less than clear, based on Press Secretary Spicer’s statements, that what was actually proposed was, in fact, a 20 percent tariff on Mexican goods. To some, it appears Press Secretary Spicer was instead giving a rough layman’s translation of an existing Republican tax reform proposal.
Tariffs v. Destination Based Cash Flow Taxation
While the Trump administration has since walked back its remarks on imposing a 20 percent “border tax” on imports from Mexico, its actions have launched conversations about the difference between tariffs and border adjustability provision of House Speaker Paul Ryan’s tax reform plan to shift corporate taxes from taxing production toward taxing consumption. As others have pointed out, “border taxes” and “border adjustability” are not the same thing, and seek to accomplish two very different purposes.
Border Taxes (“Tariffs”)
A border tax is in fact, a tariff, sometimes known as a duty, levied by governments on the value of imported product. Most tariffs are specific to a particular good or service and not the country of origin. The exceptions to this norm are “anti-dumping” tariffs, which are intended to deter countries from flooding U.S. markets with goods that are sold below cost to capture market share. For example, in May 2016, the U.S. Department of Commerce imposed a 265.79 percent tariff on Chinese steel as a result of a complaint put forward to the U.S. International Trade Commission. The tariff was levied as a punitive measure against Chinese companies that had been undercutting prices by 20 to 50 percent.
Border Adjustability and the Republican Tax Reform Proposal
In contrast to a simple tariff, House Speaker Paul Ryan has proposed a plan, A Better Way (commonly referred to as “the Blueprint”), that attempts to change the overall manner in which all business entities are taxed. Right now, U.S. businesses are taxed as U.S. citizens, meaning they are subject to worldwide taxation – they owe U.S. income tax on their profits no matter where those profits are earned, but only upon repatriation. However, business entities are highly mobile and can lower their taxes by simply filing new charters in a lower-taxed jurisdiction. Additionally, many U.S. multinational entities drive down their effective tax rates to single digits by engaging in income shifting strategies where businesses will set up subsidiaries in tax havens and then transfer profits through intercompany lending and transfer pricing agreements.
The Blueprint attempts to resolve these issues by adopting a “destination based cash flow tax,” which means modifying the income tax structure so that businesses are taxed on where their customers are rather than where they are incorporated. The destination cash flow tax incorporates two separate ideas: border adjustability and cash flow taxation. Border adjustability, as envisioned by the Blueprint, means that all imports would be subject to taxation and all exports would be exempt. Cash flow taxation, in turn, would make all capital expenditures immediately deductible, such that there would be no need to track depreciation because such investments can be expensed fully in the year of purchase. By taxing only income earned strictly within the borders of the United States (“border adjustability”), and adopting cash flow taxation principles, the House Republicans hope to modernize the business income tax structure to minimize cross-border tax arbitrage.
The Path Forward
It remains to be seen what policies the Trump administration will actually adopt. However, given the more simplistic rhetoric of the campaign trail, and President Trump’s prior statements disapproving of the “too complicated” Republican plan, it was interesting to see Press Secretary Spicer seem to embrace the latter – at least for a limited time. If anything, the “20 percent tax on Mexican imports that wasn’t” teaches us the value of waiting and subjecting the Trump administration’s statements to a deeper analysis than simply what is reported.