House Speaker Paul Ryan (R), a native of Wisconsin and known as a thought leader in the Republican party, released a campaign document in June 2016 known as the Better Way Tax Reform Blue Print (Better Way). The campaign document is primarily targeted at creating jobs and increasing U.S. manufacturing. The Better Way also addresses the perceived unfairness of other countries use of their own forms of border adjustment tax also known as value-added tax (VAT) systems. The House Committee on Ways and Means is currently drafting legislative language to reflect the principles in the Better Way with the goal of passing a bill by this summer.
VAT systems include a tax rebate for when a product is exported to a foreign country and imposes a tax when a product is imported from another country. Cross-border sales between two countries that similarly apply VAT maintain an equilibrium as the export and import taxes are offset in both countries. However, the United States does not have a VAT or a national sales tax.
The Better Way border adjustment tax
The Better Way plan introduces a border adjustment tax (BAT) that works a bit differently than traditional VAT systems and imposes a 20 percent direct tax on imports and allows for a tax exemption on all export-related gross revenue. It would also provide a deduction for domestic labor, even labor that subsidizes exports. The BAT would apply to cross border transactions of goods, services and intellectual property. While the House is drafting legislative language, it is likely that the BAT would deny a cost of goods sold (COGS) for an imported good, and would deny deductions for imported services and intellectual property.
The BAT has divided the business community. Some companies publicly support the BAT and believe it will equalize competition with foreign competitors.
Some are critical of the border adjustment plan and the reasons vary. Some believe that it takes away the ability of importers to deduct the cost of imported supplies which could have a negative impact on the economy given the United States’ reliance on supply chains.
Others point out that although the World Trade Organization (WTO) rules allow for border adjustment tax, the rules only allow such adjustment via indirect tax such as a VAT. The border adjustment tax in the Better Way plan, on the other hand, is a direct tax and could be challenged at the WTO. Also, some detractors warned that the border adjustment tax would have devastating effects on the economy and consumers.
It is unclear whether President Trump supports the BAT. He has provided mixed signals (critical of the BAT as too complicated and expression of support for applying a BAT like tax to Mexican imports).
The Trump administration’s tax policy
Although President Trump‘s advisors are still formulating his position on the Better Way plan, the administration prioritized tax reform as part of its platform during the campaign. For Business tax, President Trump identified six priorities:
- Lower the business tax rate from 35 percent to 15 percent, and eliminate the corporate alternative minimum tax. It is unclear if the reduced business tax rate will also apply to pass-through businesses or just corporations.
- Deemed repatriation of corporate profits held offshore at a one-time tax rate of 10 percent;
- Eliminates most corporate tax expenditures except for the Research and Development credit;
- Firms engaged in manufacturing in the US may elect to expense capital investments funds lose the deductibility of corporate interest expense. An election, once made, can only be revoked within the first 3 years of election; if revoked, returns for prior years would need to be amended to show revised status. After 3 years, election is irrevocable;
- The annual cap for the business tax credit for on-site childcare authorized by Sec. 205 of the Economic Growth and Tax Relief Reconciliation Act of 2001 would be increased to $500,000 per year (up from $150,000) and recapture period would be reduced to 5 years (down from 10 years); and
- Businesses that pay a portion of an employee’s childcare expenses can exclude those contributions from income. Employees who are recipients of direct employer subsidies would not be able to exclude those costs from the individual income tax and the costs of direct subsidies to employees could not be used as a cost eligible for the credit.
Although President Trump has identified these priorities, it is unclear whether they will be combined with the Better Way plan.
Will Ryan and the Trump administration see eye to eye on border adjustment tax?
At recent meetings President Trump’s advisors and House Speaker Ryan appear to be working closer together and potentially coming to agreement on tax reform. However, it is unclear whether tax reform will pass this year and whether the BAT will become law.