Border Adjustment Tax - So Where Are We?

It's tempting after last week's hearing to declare the BAT dead.  The hearing featured some very damaging testimony, and if you think that actually matters, it is hard to see how House Republicans could muster a vote in favor of the BAT with that testimony available for midterm election commercials. In choosing to have this hearing, the Republicans built the record against their own (stupid) idea.  This hearing certainly didn't convince any wavering Senators to come over to the Dark Side.

Among the hearing highlights were:

a.  The previously posted question by Rep. Jim Renacci about assurance that the dollar will adjust as predicted.  The rogue's gallery of Republican witnesses would not give that assurance. Brian Cornell, CEO of Target, helpfully openly admitted that no such assurance was possible. [Cornell was a star in the hearing.]  This question (by a Republican Congressman) crushed the Brady currency argument, and shamed the august economists who have been making unsupportable promises about the dollar saving the day for the BAT.  Smug economists have treated us all like idiots for months, but when push came to shove, no one was willing to stand up in defense of the ridiculous theory. Notably, Democratic witness and economist Kimberly Clausing of Reed College pointed out that in 75% of the cases where a country with a floating exchange rate adopted a VAT, the currency moved the wrong direction.  Oops!

b.   Most of the Republican witnesses persisted in their "correlation is causation" arguments, which rang hollow in large part because they made no sense.  The consistent theme was the simpleminded assertion that (name your economic gripe) was created by the "broken" tax system. Even Lawrence Lindsey was prone to this hyperbole.  The CEO of ADM even asserted that declining sales of his commodities was due to our tax system.  He should be embarrassed for stooping this low.

c.    Devin Nunes continued to parrot the party line (as did Peter Roskam, the other Brady attack dog at the hearing).  In this case, he repeated the nonsensical observation that "Iraq, Syria, North Korea and Mali" don't have VATs, hence we're nuts to not grab the VAT idea while we can.  Among the objections raised to this "insight" was the fact that the BAT is not a VAT, and no conclusions can therefore be reached by Nunes' absurd oibservation.  Rep.  Doggett pointed to the esteemed economies of Estonia and Latvia which have VATs but have not shown great growth.  This counter-argument seemed to have as much impact of Nunes'.

d.   Rep. Sanford Levin made some very strong points, such as the fact that we have lost WTO cases in the past that relate to proposed taxes like the BAT.  He also took issue with the notion that economic ills are directly traceable to tax systems, pointing to labor arbitrage as a big driver of moving jobs overseas.

Duh.

He also noted that everyone pays corporate income tax in their home country, hence an actual level playing field.

e.   Although no one took on the tedious mathematics of VATs, the urban myth of profiting from border adjustments was repeated but with little impact.

Notably, Rep. Erik Paulsen came out explicitly against the BAT.  With Rep. Kelly and Renacci on record against it, the Republican "no" votes on this bill seem to make it impossible to move forward.  Paulsen's move seems particularly portentous, so much so that it suggests that Brady and Ryan were trying to set up a shift in position through Paulsen.  I say this because Paulsen is a very close associate of Brady, and one wonders how Paulsen could take such a contrary and embarrassing position right in front of his patron and friend if it were not cleared in advance.  And if he did clear his plan with Brady, then Brady may finally be ready to trade this awful proposal away.

The question is when.  Given the chaos in the White House and disarray on several fronts in Congress owing to many factors, including the distraction of meltdown in the Trump agenda, Brady is said to be unsure of what happens next.  He is rumored to hold the BAT as a fallback position when nothing else works.  I wonder if this is credible in any way after this hearing.  In my opinion, he can't overcome the record now.

Other rumors suggest that Brady and Ryan are prepared to trade the BAT for a modified territorial tax system wherein foreign profits would taxed at lower levels than today, but not at zero.  This would raise replacement revenue in some amount to replace the prospect of the BAT revenues. A modified territorial system would be better than nothing at all, and no business would suffer at the relaxing of this tax (the savings are less than a total removal of the tax, but something is better than nothing, right?).

As long as Brady and Ryan are prepared to sustain the notion that the BAT has a chance of becoming law, we cannot give up our opposition.  That said, it seems like it's just a matter of time now. Let's keep pushing and hopefully, Brady and Ryan will eventually concede that there have better things to do with their time than push for this terrible tax.

Border Adjustment Tax Clips - May 25, 2017

Bloomberg:  Former Ex-Im Chairman Says Border Tax Not Happening  5-25-17

Foreign Affairs:  A Tale of Two Tax Plans  5-24-17

The Hill:  Border-adjustment tax proposal at death’s door  5-24-17

Vox:   Nobody likes the border adjustment tax — except the House Republicans who won't let it go 5-24-17

EPR Retail News:  The Border Adjustment Tax Would Jeopardize 42 Million Jobs Retailers Currently  Support  5-24-17

Fox Business:   Sen. Toomey: "Going to end up without having much of a [BAT]"  5-24-17

Bloomberg:  Ryan Isn't Folding on Border Tax, Says He's Talking About It  5-24-17

Bloomberg:  Mnuchin Tells Democrats No Go on Border Tax in Private Meeting  5-24-17

Axios:  Speaker Ryan on if Tax Reform Is possible w/o BAT: "Of Course" 5-23-17

Washington Free Beacon:  Business Owners Tout Tax Reform but Some Oppose Border-Adjustment Tax  5-24-17

Fox Business:  House GOP Tries to Keep Border-Adjusted Tax Alive 5-23-17

Politico:  Central pillar of House tax reform plan draws friendly fire  5-23-17

Bloomberg:  Mnuchin Cites Border-Tax Concern as House Panel Seeks Tweaks  5-23-17

TheStreet:  Mnuchin Puts Kibosh on Border Tax as House Debates Measure  5-23-17

The Hill:  Hearing highlights GOP divide over border tax  5-23-17

Star-Telegram:  Target CEO tells Congress that GOP’s proposed import tax would hurt his customers  5-23-17

NY Times:  Border Tax’s Apparent Demise Jeopardizes G.O.P. Overhaul Plan  5-23-17

Washington Post:  GOP divisions grow over proposal for a border adjustment tax  5-23-17

Bloomberg:  Target CEO Says Border Tax Could Hurt American Families  5-23-17

WSJ:  House GOP Tries to Keep Border-Adjusted Tax Alive  5-23-17

Politico:  Central pillar of House tax reform plan draws friendly fire  5-23-17

The Dallas Morning News:   House GOP tries to rally support for border tax proposal that's divided Texas' business community  5-23-17

Tampa Bay Business Journal:   Target, Beall's, other retailers speak out against border tax 5-23-17

Washington Examiner:   Border adjustment tax proponents struggle to prevent more Republican defections 5-23-17

Morning Consult:   Challenges Facing Border Tax Plan on Display at Ways and Means Hearing 5-23-17

CNBC:  Mnuchin: BAT Doesn’t Create Level Playing Field  5-23-17

E&E News:  Lawmakers to debate border adjustment plan  5-22-17 

US News & World Report:  Border Adjustment Tax Faces Uphill Battle  5-22-17

Chron.com:  Texas businessman (and friend) flies to DC to oppose Kevin Brady's border tax plan  5-22-17

The News & Observer:  This small business owner says he can’t survive a Republican plan to tax imports  5-22-17

Fayetteville Observer:  A border tax will hurt business here  5-20-17

Weekly Standard:  The Right Cure  5-20-17

The Leader:  Border Adjustment Tax will harm Texas consumer economy  5-19-17

Wall Street Journal:  Key Republicans Change Stance on Trump  5-19-17 

Convenience Store Decisions:  NRF Fights Consumption Tax Proposal  5-18-17

Fox Business:  Jim Jordan on BAT: "I don't think that's what Republicans are about"  5-18-17

The Ledger:  A Polk Perspective: Border Adjustment Tax would be devastating to Florida  5-18-17

World Trade Online:  Brady touts border-adjustable tax in House GOP plan; Mnuchin skeptical  5-18-17

Politico:  Kochs boost Trump tax plan  5-18-17

Law360:  GOP Has No Tax Plan B Without Border Adjustment, Rep. Says  5-18-17

Bloomberg:  Sen. Perdue on what tax reform should really focus on  5-17-17

CNBC:  Rep. Kustoff has concerns on BAT  5-17-17

Chicago Tribune:  Trump support in Congress shows signs of crumbling  5-17-17

Politico Pro:  Wall Street gives up on a 2017 tax overhaul  5-17-17

The Hill:  House GOP not sold on Ryan’s tax reform plan  5-16-17

Can Anyone Assure Us that Currency Adjustment Will Eliminate Cost Impact on Consumers? NOPE.

Congressman Jim Renacci had an interesting question today at the BAT hearing:

RENACCI: “So to each witness, can any of you assure me that the currency will adjust so that there will be no effect to the cost of our consumers? Yes or no to each one of you.”

CORNELL: “No, I can’t.”

LINDSEY & SIMON: Silent. (U.S. House Ways & Means Committee Hearing, 5/23/17)

Border Adjustment Tax Hearing by House Ways and Means Committee May 23, 2017

AAP Fact-checked House Ways and Means "Communication Document" for May 23rd Hearing

The Americans for Affordable Products coalition did some homework to prepare the Ways and Means Committee for tomorrow's hearing.  See their memo below and definitely check out the linked document:

MEMO

To: House Ways and Means Committee

From: Americans for Affordable Products

Date: May 22, 2017

Re: Fact Checking “Communications Document for May 23 Tax Hearing”

---

Last week, the House Ways and Means Committee released a document to its members providing guidance for their May 23, 2017 hearing on the Border Adjustment Tax (BAT) called “Increasing U.S. Competitiveness and Preventing American Jobs from Moving Overseas: Communication’s Document for May 23 Tax Hearing.”

Unfortunately, the Committee got it wrong by misrepresenting the truth about the BAT and taking out context statements made by companies who oppose it.

A corrected version can be found here: “Increasing the Tax Burden on Working Families So Some Profitable, Multi-National Companies Operate Tax Free: Communications Document for the May 23 Tax Hearing.”

Please consider using the content in this document as you prepare for tomorrow’s hearing.

Hearing on How Tax Reform Will Grow Our Economy and Create Jobs (Ways and Means Committee Hearing on May 18)

How to Watch the Ways and Means Tax Policy Subcommittee BAT Hearing at 10 AM EST on May 23, 2017

Peter Roskam's Tax Policy Subcommittee will be hosting a hearing at 10 AM EST on the subject of the Border Adjustment Tax.  It is misleadingly named "Hearing on Increasing U.S Competitiveness and Preventing American Jobs from Moving Overseas".  What else do you expect?

The witnesses include:

Juan Luciano
President and Chief Executive Officer, Archer Daniels Midland Company
Testimony

Brian Cornell
Board Chairman and Chief Executive Officer, Target Corporation
Testimony

William Simon
Former President and Chief Executive Officer, Walmart U.S.
Testimony

Lawrence B. Lindsey
President and CEO, The Lindsey Group
Testimony

Kimberly Clausing
Thormund A. Miller and Walter Mintz Professor of Economics, Reed College
Testimony

You can watch the hearing live HERE.  I will post the video afterwards.

It will be interesting if there is any sign of listening going on.  The Americans for Affordable Products coalition will be releasing a barrage of materials throughout the day.

My Statement on Border Adjustment Tax for May 23rd Tax Policy Subcommittee Hearing

Statement of Richard Woldenberg on Border Adjustment Tax

Submitted to the Subcommittee on Tax Policy

of the House Committee on Ways and Means

The United States House of Representatives

May 23, 2017

My name is Richard Woldenberg, and I am CEO of Learning Resources, Inc. located in Vernon Hills, Illinois. I am submitting this testimony on behalf of our company. Our company is a family business which develops and markets educational products and educational toys in the United States and dozens of other countries.  We outsource the manufacturing of our products overseas, and as a result, we are a significant importer (of our own products) into the United States. 

We have grave concerns about the Border Adjustment tax proposal being considered by the House Ways and Means Committee as originally described in the “A Better Way” plan.  The proposal is rife with risk and unintended consequences. I fear that the future of our company, and the jobs we provide, are at stake.  We are a small business under the Federal government definition and believe that the problems we will face under the Border Adjustment tax proposal will be experienced by thousands of other small business importers in the United States.

Our Company: 

Learning Resources, Inc. (LR) was founded in 1984 and is located in Vernon Hills, Illinois and has about 150 employees in the U.S. and U.K.  The company is part of our family business group which turned 100 years old in 2016; I am in the third generation of my family to run this business, and we were proud to welcome the first member of the fourth generation into our business this year.  LR develops and markets proprietary educational toys and materials in Vernon Hills but manufactures its 1400 products overseas.  Jobs at our company pay well, turnover is low and we are an important part of our community, injecting many millions of salary and benefit dollars into the local economy annually.  In 2013 and again in 2016, LR tried and failed to find U.S. molders interested in making our products here. In other words, we know from recent experience that we have no realistic option to make our products in the U.S., with or without the incentive of a reconceived Federal tax regime.  

The Issues Created by Border Adjustment Tax (BAT):

1.      We will become the involuntary subject of an historic exchange rate experiment.  The BAT plan is unprecedented in U.S. history and its effects are unknown and unknowable.  The plan is premised on a surging dollar that erases import costs. Betting the U.S. economy on a rising dollar is irresponsible – we shouldn’t confuse being “bold” with being reckless.  Tax policy based on presumed changes in the value of the U.S. dollar is simply gambling.  We cannot afford tax policy based on hunches, regardless of the resumes of those who pound the table promising dollar nirvanas.

Economists Auerbach and Holtz-Eakin assert that U.S. dollar appreciation after implementation of the BAT will reduce importers’ Cost of Goods Sold (COGS) enough to pay the new Federal tax bill. This is the basis of the contention that the plan simply “levels the playing field” without affecting cash flows. The economists offer little more than bland assurances, however.

The plan’s flaws are manifest:

-          Congress can’t accurately predict the course and direction of financial markets and hence can’t be certain of future exchange rates.  What if the predictions of massive U.S. dollar appreciation are wrong?  What if the changes are smaller or larger than expected, or arrive later, or fade over time? After all, foreign exchange markets are massive, and dominated by large pools of capital not tied to trade.  Tax policy is hardly the only factor which drives exchange rates. Interestingly, economists have given a name to the inability to predict exchange rates:  The Exchange Rate Disconnect Puzzle.  See

https://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=2&ved=0ahUKEwjt1LSc4YLUAhXL5YMKHZrnArkQFggtMAE&url=https%3A%2F%2Fwww.dallasfed.org%2Fassets%2Fdocuments%2Fresearch%2Feclett%2F2008%2Fel0806.pdf&usg=AFQjCNGGj0SNFH-Q5SRwd2vcQBn-SrkTEA&sig2=LiFrN9xlIWK6Mr-MqLxR6A  It is an accepted fact that movement in exchange rates cannot be foretold.

-          The cost of imported goods will always include foreign content.  For instance, foreign-made clothing often includes U.S. cotton or U.S. thread.  Toys made in China often use imported plastics, paper or wood.  Oil and gasoline are also foreign inputs. Foreign inputs rise in cost as the dollar rises, while only local content falls in cost. Our factories estimate 30-65% of our product cost is foreign-sourced.  This means that our factories’ overall costs will likely RISE when the dollar rises.  The economists’ assertion of cost savings is illusory.

-          Dollar-denominated costs are the norm for U.S. importers.  As the dollar rises, dollar-based costs don’t decline – they are fixed by contract.  Realizing savings will require a line-by-line renegotiation of our entire business, essentially a zero-sum game with our factories.  Factories may well refuse to cooperate with any effort to ratchet down dollar-based costs.  In any event, cost reductions required to balance out the BAT will be epic and FAR beyond any cost reduction achievement in our company history.  To fund the BAT, we will need to lower costs by as much as 19% which is frankly absurd.  This cost savings is presumed by supporters of the BAT, but it’s entirely unrealistic.

-          We believe there are other risks to the exchange rate scheme, including resistance by other countries (in the form of currency manipulation or interest rate changes). There is no guarantee that the dollar will move equally in all markets, for any number of reasons, so there is likewise no guarantee that costs will actually decline. We also believe we will be subject to significant changes in the terms of our bank line of credit owing to novel currency risks imposed by the BAT.  Instability in bank financing could be devastating for many companies.

Unlike the 1986 Reagan tax plan, the BAT has no fallback position.  If the Reagan plan didn’t work, the Federal government had the option to raise tax rates and no company would have been damaged.  Under the BAT, corporate restructuring for many businesses seems inevitable and significant job losses likely.  If the theory behind the BAT doesn’t hold, Congress will not be able to resurrect the companies killed by the BAT.  Humpty-Dumpty can’t be put together again.  Policy makers should not take such risks with American livelihoods.

2.      The BAT will likely trigger a highly-regressive inflationary firestorm.   When it becomes clear that importers will have no realistic way to capture sufficient cost savings to pay the enormous increase in taxes caused by the BAT, there will be no choice but to pass the costs along to consumers. And of course, consumers always bear the cost and consequences of tax increases like the BAT.  We estimate that costs will ultimately rise as much as 20% under the BAT.

The mechanism for the price hike is being demonstrated in the U.K. right now.  The collapse in the value of the British Pound from $1.50 (on the evening of the Brexit vote) to a recent low of $1.21 mimics the inflationary pressures likely created by BAT-induced dollar appreciation. Sharply rising U.K. consumer prices from import cost inflation strongly suggests that consumer inflation will naturally occur here under the BAT.  Like a value-added tax, this rise in consumer costs will be regressive in nature and strike hardest the most vulnerable in our economy.  A large population of defenseless constituents will find their standard of living slipping into decline post-BAT.

For example, see these news reports of U.K. price hikes:

          https://www.wsj.com/articles/brexit-comes-with-price-shock-at-checkout-1489512547 (Brexit price shocks hits consumer products)

https://www.theguardian.com/business/2016/dec/14/lego-to-raise-its-prices-in-uk-from-january-sterling (LEGO raises prices due to British Pound weakness)

http://www.toynews-online.biz/news/read/lego-reportedly-raising-prices-in-the-uk-by-5/047893 (LEGO letter explaining price increase)

http://toyworldmag.co.uk/blog/the-end-of-days-its-the-friday-blog/ (Battle between retailers and suppliers over cost of the British Pound decline)

http://www.independent.co.uk/news/business/news/brexit-microsoft-prices-rise-pound-slump-value-software-impact-a7378181.html (Microsoft hikes prices 22% over British Pound decline)

http://www.independent.co.uk/news/business/news/brexit-pound-value-christmas-pudding-prices-rise-a7445476.html (Supply chain costs cause 21% rise in cost of Christmas pudding)

http://www.cyclingweekly.co.uk/news/latest-news/brexit-will-be-the-cause-of-possible-brompton-cost-increase-in-uk-298369 (UK bike manufacturer may raise prices because of currency-related supply chain cost increases)

http://europe.autonews.com/article/20161006/ANE/161009940/ford-vauxhall-nissan-raise-uk-car-prices-after-brexit  (Ford, et. al., raises car prices because of component costs in locally-made cars).

https://www.thesun.co.uk/news/2517213/marks-spencer-to-increase-prices-by-up-to-15-despite-making-post-brexit-promise-to-protect-shoppers-from-devaluing-pound/ (Marks & Spencer reverses course and increases prices 15% because of the Pound).

3.      The BAT will almost certainly spark trade wars.  Economists supporting the BAT confidently predict an “immediate” 25% appreciation in the U.S. dollar after the BAT is implemented (based on a 20% Federal tax rate for “C” Corps).  Simple math indicates that this translates into a British Pound at parity (the lowest exchange rate ever), the Euro at $.80 (near its all-time low of $.70 in 1985), and almost certainly a broken peg for the Hong Kong Dollar and other key currencies tied to the dollar. Such sharp U.S. dollar appreciation can be expected to devastate U.S. exports. The theory that the BAT will stimulate export sales seems dubious in light of a skyrocketing dollar, and therefore the value of the BAT tax holiday on export sales is of limited value.

The likely financial impact of this Congress-induced currency manipulation certainly seems calamitous. It seems delusional to believe that other countries will simply sit idly by and let the United States inflict this kind of harm on their economies.  Consider Canada as an example.  Canada was the third largest exporter to the U.S. in 2016, with total exports of $278 Billion.  The BAT on that flow will be approximately $56 Billion, half the projected annual “take” under the BAT.  Some estimates indicate that 75% of Canadians live within 100 miles of the U.S. border.  Consider the impact of that tax on the Canadian economy and the population living near the U.S.  Will Canada elect to just “take it”? No chance. Add to this the fact that Canada also imported $266 Billion from the U.S.  The BAT will give American exporters a significant edge in competing with Canadian suppliers by eliminating income tax.  Canada will get it coming and going under the BAT.  I am sure Canadian legislators will quickly find inspiration to give the Americans a taste of their own medicine.

It is implausible that these effects will be ignored.  To seriously entertain the notion that other countries won’t find ways to retaliate is to engage in happy talk.

4.      Preventing inversions but opening up other gaping tax loopholes at the expense of our jobs and our company is unacceptable.  Eliminating the inequity of companies implementing tax gambits like inversions would make the U.S. tax system fairer, certainly. We feel the pain because we pay a far higher tax rate (43.6%) on our worldwide pretax income as an Illinois-based “S” Corp. We do not shop internationally for low tax rate jurisdictions. We believe we are typical of American small businesses. While it may be galling that some taxpayers pay much less, unjust enrichment of others does not actually make us poorer.  It is even MORE galling, however, to know that we are being asked to sacrifice our businesses so large highly-profitable mega-corporations can be excused from paying any tax under the BAT. That’s even more unfair than the current situation and will outrage ordinary taxpayers once they realize what has happened.  We would be much better off if Congress did nothing.

5.      We are a Small Business job creator but our job creation engine will be eviscerated by the BAT.  Our products were developed by Americans in the United States, our intellectual property is owned in this country, and we created about 150 jobs by developing a market for our educational products.  We are not ashamed of our decades-long record of helping American kids learn and American families improve their standard of living with products that we make offshore.  If we must nevertheless reorganize to fund the BAT, however, we will be incentivized to eliminate as many high paying jobs as possible – we will recapture 75 cents for each dollar of expense eliminated at the new tax rate.  Investments in automation will become much more attractive – and will be immediately deductible under “A Better Way” plan. How does the BAT create enough jobs to compensate for job losses like these all over the country?

Notably, 97% of U.S. importers are Small Businesses, according U.S. Census data from 2014.  The average import value per annum per congressional district is about $1.5 billion from Small Business alone, meaning that each district will pay $300 million in extra taxes under the BAT.  The annual import value (2015) for the U.S. Small Business community - $631 billion (https://www.census.gov/foreign-trade/Press-Release/edb/2015/exh1d.pdf) – would fully fund the projected $1.2 trillion ten-year revenue raised by the BAT.  In other words, the BAT is a Small Business tax.  According to the U.S. Census Bureau, there were more than 191,000 small business importers in 2015 in the United States.  That’s a lot of small business jobs at risk under this proposal.

6.      Long-promised lower Federal corporate tax rates will not translate into lower tax bills under the BAT.  Despite the expected 25% rate for “S” Corps under “A Better Way”, our company’s Federal tax bill is expected to increase by 4-5x. Based on our actual 2016 results, we project paying a 165% tax bill at the 25% rate for “S” Corps. The negative impact of BAT math intensifies as Cost of Goods Sold (COGS) grows as a percentage of sales. In other words, the tax is regressive in the corporate community, by pinching the lowest margin companies most deeply.  

Notably, importers will face giant tax bills even in years when they are losing money. This is simple math – importers might have no GAAP earnings but high imported COGS, and thereby will generate a huge Federal tax bill with no money to pay it.  Does the House Committee on Ways and Means want such companies to die quickly? We believe that companies facing financial difficulties or going through a turnaround will shed jobs in droves post-BAT just to survive, or simply go out of business.  The BAT will lead to death by Federal taxes.

7.      The shift of tax base from GAAP earnings will create great risk for companies and unpredictable tax outcomes.  We finance our business based on predicted cash flows.  Taxes under American law have always been a fraction of earnings, which facilitates planning and certainty.  As an importer under the BAT plan, our Federal tax bill will greatly exceed our GAAP earnings, and our ability to pay will depend on various factors largely out of our control. Planning and certainty are no longer possible. If we fail to capture savings from dollar appreciation for any reason (meaning that we must sharply reduce our product costs, bring the inventory in, sell it at unprecedented profit margins and collect the cash, all in time to fund a quadrupled tax bill) we will either incur losses to pay taxes or have to restructure our business to survive.  We don’t know what our business looks like under these conditions.

8.      Foreign VAT systems do not put American products at a disadvantage. The BAT purportedly addresses a longstanding disadvantage created by foreign value-add tax systems (VAT). This is an urban myth. In fact, VAT is a tax paid by consumers in lieu of personal income tax.  The BAT is a corporate income tax, not a personal income tax substitute. This is apples-and-oranges. VAT is paid in full by the last buyer in the chain of commerce, the consumer. No one pays anything in the chain other than the consumer by definition under a VAT. Foreign corporations pay tax on their earnings just as we do in this country (corporate income tax).  U.S. tax treaties ensure that no corporate profit dollar is taxed twice. [The fact that U.S. corporate tax rates are the third highest in the world, behind the U.A.E. and Chad, is probably the root cause of inversions, not the “attractiveness” of VATs.]  VAT does not convey advantage to anyone.

Second, the VAT “border adjustment” on export is simply a governmental rebate of excess tax receipts to the company that paid the taxes.  It is not a subsidy. This is a mathematical fact, but we also know this from personal experience. Since 1994 we have operated a company in the U.K. and export from the European Union regularly.  If VAT border rebates were actually an export subsidy as has been alleged, we would have been receiving this subsidy since 1994.  Although we produce audited financials for our U.K. business, there is no line in those financials for VAT revenues or VAT profits.  There is no such thing. Large multinational corporations have been chirping about the “unfairness” of VAT border adjustments in support of the BAT, but notably they are also significant exporters from VAT jurisdictions.  If it is possible to profit from VAT, as they assert, they themselves must be receiving this subsidy.  The Committee should request information on the benefits large multinationals have received over the last 20 years under VAT tax regimes.  Such requests will be greeted with silence.

Finally, the assertion that VAT border adjustment is unfair to Americans is implausible given the careful scrutiny given to trade disputes under GATT. Since 1947, the U.S. has been involved in 379 cases at the WTO either as a plaintiff, defendant or other participant.  That’s a major WTO lawsuit involving the U.S. approximately every two months for 70 years. If VAT “border adjustments” have been so prejudicial to American exporters since 1947, why hasn’t it been litigated by the United States?  Such a serious charge deserves much greater scrutiny.

Financial Models:  I have attached model financials for two hypothetical toycompanies, one with gross margins of 38% (yellow highlights) and one with gross margins of 25% (orange highlights).  The 25% gross margin company operates on lower expenses to make similar money (for instance, they might be a “make-to-order” company without a warehouse).  Both companies are modeled with simplifying assumptions under the BAT, focusing on the impact of the loss of the COGS deduction. Both companies are modeled as an Illinois-based “S” Corp with steady State taxes.

There are four scenarios presented for each company:  (A) current tax law, (B) “A Better Way” Blueprint, (C) Post-ABW (details below), and (D) Economists Optimistic Scenario (details below).  Scenarios C and D are essentially opposite scenarios.  Scenario D illustrates what economists predict, namely that companies will capture COGS savings from U.S. dollar appreciation to fully pay their new BAT tax bills. Scenario C models what happens when companies capture none of the predicted currency benefits, leaving the model companies no choice but to raise prices (up 34%) and reduce expenses (down 20%) to preserve their financial results. This response will also trigger an immediate sharp decline in sales (down 40% in units).  These two scenarios produce the same cash flow as the current law scenario (A) but only with major operational changes. None of scenarios B, C or D are better than the status quo for the model companies, or our company, or the thousands of similarly-situated companies all over the United States. 

I would like to draw your attention to the relationship of Payroll expense to net taxable income in the models.  Payroll expense (jobs) is much greater than pre-tax profit in most companies.  The true social impact of independent businesses stems from their payroll expenses (in other words, jobs, jobs, jobs). This is certainly the case for multi-generational family businesses like ours which are the bedrock of communities through good times and bad.  But the BAT threatens payrolls at small business importers. Consider how much Federal taxes increase in the new plan (B v. A) despite the reduction in rate from 39.6% to 25%. The Federal tax bill skyrockets.  In the examples here, the Federal tax bill goes up between 8.1x and 11.4x. [A more thorough modeling against our actual financials shows taxes rising between 4-5x over today’s 39.6% Federal tax bill.] Clearly new Federal taxes will endanger payroll expenses (jobs). Is this what taxpayers want? 

It is important to note that in the examples here, the model companies must recover 24% of COGS, presumably through resetting dollar contracts after the dollar appreciates by the promised 25%. That’s a fantasy of massive and unachievable savings. We are ecstatic if we can shave 1% off our COGS in any given year. Suspending disbelief, please consider what this asserted exchange rate value transfer means to the guy on the other side of the trade (our vendors).  The BAT proposal will suck wealth from every country in the world over to the U.S.  By manipulation of the Federal income tax code, Congress will thus force us to become the agent which lands this big wealth transfer . . . all so we can hand it over to Uncle Sam. Not a very appealing prospect, especially because it must be played out against our long-time, trusted vendor partners.  This will devastate critical business relationships. Shaking down our supply chain to pay a huge increase in Federal taxes means we become the government’s shills.  This is obviously bad tax policy.

No matter how the BAT is spun by the talking heads, no one is going to miss the point that importer tax bills are going to multiply under the BAT.  As more business owners and their accountants do the math, and realize that they face unimaginable tax burdens never seen since the institution of the Federal Income Tax system in 1913, they will rise up against the politicians who devised the plan.  The voters’ anger will only mount as job losses pile up and prices rise.

There must be another, better way to fix the tax system in this country, and it is Congress’ responsibility to find it. Thank you for considering my views.

Border Adjustment Clips May 22, 2017

Bloomberg:  Koch Study Takes Aim at Full Expensing in House GOP Tax Plan  5-17-17

Bloomberg:  Brady Sets Border-Tax Hearing Even as McConnell Predicts Failure  5-17-17

Washington Examiner:  GOP's controversial import tax plan gets a hearing  5-16-17

Retail Dive:  Retail execs to meet with Treasury chief on border adjustment tax  5-16-17

The Hill:  House GOP not sold on Ryan’s tax reform plan  5-16-17

Tampa Bay Times:  Border tax would hit consumers hard  5-16-17

Market Watch:  U.S. oil prices will skyrocket if border tax comes in, says Goldman’s Currie  5-12-17

Detroit News:  Border adjustment tax carries unintended consequences  5-11-17

The Hill:  Senate confirms Trump's chief trade negotiator  5-11-17

Columbus Dispath:  Speaker Ryan, Drop the Border Adjustment Tax  5-10-17

Fox Business:  Rep. McCarthy on BAT: "Very difficult to get through"  5-10-17

Roll Call:  Ryan to Sell Tax Overhaul Benefits in Ohio  5-10-17

Columbus Dispatch:  On eve of Ryan visit, Ohio business group speaks out against proposed tax on imports  5-10-17

Bloomberg:  Cohn, Mnuchin Oppose Border Tax, Hatch Says  5-10-17

Reuters:  U.S. Senate finance panel unlikely to support import tax: chairman  5-9-17

Washington Times:  The ‘Made in America’ tax myth  5-9-17

MLive:  Top Toyota officials talk fuel standards, border tax in Ann Arbor visit  5-9-17

Daily Herald:  Border adjustment tax could devastate Illinois importers and jobs  5-8-12

The Hill:  GOP senator: Border adjustment tax would be 'dead on arrival' in Senate  5-7-17

CNBC:  A border adjustment tax is not productive, former Varsity Brands CEO says  5-7-17

Washington Times:  Trump must battle BAT  5-7-17

Greenville Online:  Commentary: Why import tax would hurt consumers  5-5-17

CNBC:  Trade Advisor, Matthew Rubel on BAT: "Lead[s] to more unemployment"  5-8-17

Bloomberg:  The impact of changes to border tax policies  5-4-17

Aftermarket News:  Border Adjustment Tax To Cost Car Owners $160 More Per Year For Auto Repairs And Maintenance, Association Says  5-4-17

Latest News on the BAT

As one crazy week winds down, and another presumably ramps up (Merrick Garland for FBI Director, says Mitch McConnell!), there have been a couple more Border Adjustment Tax tidbits worth pondering:

a.  Mnuchin tells G-7 that Border Tax isn't part of his plan.  On Saturday, Treasury Secretary Steven Mnuchin reassured G-7 nations that he won't be including the BAT in his tax plan.

“'The emphasis was initially on a border tax, which is taxation, but also trade policy,' said Italian Finance Minister Pier Carlo Padoan in an interview. 'Now, the emphasis—and Secretary Mnuchin was very clear about this—is about tax reform.'”

So Mnuchin says NO on BAT in public to allies.  Good sign.

b.  President Trump Explains the role of the BAT in his tax plans.  Mr Trump's words can't be summarized, you must read them yourself.  This is from the transcript of his interview by The Economist, a fascinating document, worth a scan (believe me):

"But as you said Mr President, a border-adjustment tax has some similarities to that. Are you still considering a border-adjustment tax?

We are dealing with Congress…because it’s not really what I’m considering. I mean look, on health care, I think we have a great bill and there’s still a little bit further to go because we’re also dealing with the Senate, but the Senate I believe really wants to get something done because Obamacare is dead, just so we understand. Obamacare is absolutely dead. The insurance companies are leaving. Yesterday Aetna just announced they’re pulling out. You have states that aren’t going to have any insurance companies. You know when people say, “Oh, Obamacare is so wonderful,” there is no Obamacare, it’s dead. Plus we’re subsidising it and we don’t have to subsidise it. You know if I ever stop wanting to pay the subsidies, which I will.

You’d pull the plug on that? If this bill doesn’t go through you’d stop those subsidies?

No, this bill only gives them one month. They don’t realize that, that’s another thing. Good point. This bill gives them one month, it gave, you know the subsidy…

The continuation of the subsidy?

The subsidy to the insurance companies, yes. Anytime I want because actually."

Uh-huh, I get it now . . . .  Btw, this is real, check the link.  And if that's not convincing, please note the New York Times' description of what it's like to speak for Mr. Trump.

c.  South Carolina Republican Party Adopts Resolution Against BAT.  A big slap in the face for Mr. Ryan and Mr. Brady from a core Republican State.  See the resolution here.

A busy weekend of news, and next up are the hearings on Thursday.

Chaos in Washington . . . but a Few Thoughts on the BAT Anyway

The repulsive degradation of national leadership in the last few days certainly sapped my energy.  Nevertheless, despite the downward spiral of the Trump Presidency and its implications for the prospects of the BAT, we are not out of the woods, and must keep the pressure up.

A few tidbits of news for you:

Ways and Means Hearing Set for Thursday:  Kevin Brady and Peter Roskam called hearings for May 18th on tax reform.  Let's not do cartwheels yet.  This is something like a Soviet show trial. The outcome of the "hearing" is known in advance.  Please don't mistake the hearing for an actual interest in dialogue or fact finding.  This is about creating a record to justify what they always wanted to do.  In any event, Steven Mnuchin tweeted his approval, noting the need to "emphasize economic growth".  As previously noted here, the anti-growth aspect of the BAT kills it for the estimable Trump Administration.

House Majority Leader Kevin McCarthy Admits the BAT is not going well. McCarthy actually said it will be "very difficult" to get through.  See the video:



Frankly, tax reform seems remote given the controversy paralyzing Washington right now.  Let's not forget that health care must come first, then a budget, then tax reform.  And the Trump plan imposes ridiculous financial stress on the American economy with skyrocketing fiscal deficits, something this Congress is highly unlikely to approve.  Then what?  Who knows.

An interesting next shoe to fall is when Congressional Republicans start to turn on Mr. Trump.  He may have started this process with the Comey firing.  In my book, that all but ends tax reform and with it goes the BAT.

Follow up on Canada:  In my last post, I noted that the imposition of the BAT on Canadian imports into the U.S. will generate about half of the expected value of the BAT.  Whoa.  Please note, however, that the BAT proposal also eliminates tax on all U.S. exports to Canada.  With $266 BB in 2016 exports to Canada, the elimination of income tax on those sales will be quite a shot in the arm for U.S. exporters' competitiveness in Canadian markets.  Think they'll notice?

To put this in perspective, please remember the hullabaloo over the 20% tariff recently imposed on Canadian softwood-lumber exports to the U.S.  That sudden move spurred an immediate series of interactions between the U.S. and Canada, including calls between Justin Trudeau and Trump.  And how much was at stake?  $1 BB in tariffs on $5 BB in U.S. imports.  This absolutely pales in comparison to the shocks that the BAT would impart on both Canadian imports here and U.S. exports into Canada.  One billion dollars is just chump change by comparison.  Yet the BAT continues to enjoy the support of House Republican leadership.  Does not compute.  Does not compute at all.

More to follow, no doubt.

Peter Navarro's Star Fades but that Doesn't Mean the BAT is Dead

The WSJ notes that Peter Navarro, Trump's far out adviser on trade, has been marginalized in the White House after a power struggle with less heart-of-darkness Administration officials like Gary Cohn.  According to the WSJ article, Navarro is now in charge of a staff of two, including himself, and has a 15 minute weekly window to meet with President Trump.  Many of his wackiest (read, most dangerous) ideas have been tabled, discredited, abandoned (you get it).

All of this is good because it reduces the likelihood that the White House will somehow turn around and favor the BAT. Navarro was the most vocal of White House officials behind the BAT, and with his star fading away, it seems unlikely that the collection of actual business people in the White House will take the risk of supporting the dangerous and ill-conceived Border Adjustment Tax.

Then again, they do want our money.  So it's not over yet.

An interesting way to understand, yet again, how dangerous and unpredictable the BAT would be is to consider the integration of our economy with Canada.  That issue gets most of its air play in discussions of NAFTA.  However, the indiscriminate BAT does not care about NAFTA. Everything from Canada would be taxed under the BAT.  Canada is the U.S.'s number two trading partner, to the tune of $544 BB per year (2016).  This is just shy of China, if that gives you a sense of how gigantic the trade flows are.  Canada is the third largest exporter to the U.S. ($278 BB) behind China and Mexico.  The 20% bill under the BAT for importing from Canada will be a cool $55 BB per year, about half of the net raise expected under the BAT.  Think about how well that will fly in the Great North,

Another aspect of this is to consider the on-the-ground impact of this law on Canadians.  It may surprise you to learn that 75% of Canadians are estimated to live within 100 miles of the U.S. border. Other estimates suggest as many 90% live by the border.  The folks that live near the U.S. are very often involved in business activities with the U.S.  Goods (and components) go back and forth across the border, as do services, and many businesses are active on both sides of the border.  The scale of this activity is mind-boggling.  With so many folks living right up against the border, it can be anticipated that a BAT in the U.S. could devastate the Canadian economy.  Much more than a "shock".

If this is true, how could it be in our interest to "restructure" our "broken tax system" to expose the world's leading economy to this risk?  We are also the strongest economy.  Yes, it's crazy and yes, it's unimaginably irresponsible.  The response of economists, where they reassert the theoretical underpinnings of the BAT proposal, is completely unresponsive to this known risk. Theory aside, how do we make such a proposal workable, under any circumstances, when so many people will be instantly whacked?  This has dramatic foreign relations implications, and unknown economic and legal consequences.  The likelihood of serious and immediate (or preemptive) retaliation also seems very, very high.

I think I read that in "Duh" Magazine.

You can add to that the ripple effects on the U.S. economy from the BAT's impact on Mexico. Trade deficit hawk and notorious paranoid Peter Navarro might assert that it is in our best interest to issue these shock waves. Hence the good news that he is working out of a White House closet these days. Let's hope he stays there.

Frankly, this is a sad, sick joke.  The politicians should hang their heads in shame for even proposing it.  It's malpractice. But then again, they're politicians.  What do you expect???