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A Border Adjustment Phase-in?

5 min readBy: Kyle Pomerleau

Today, House Ways and Means CommitteeThe Committee on Ways and Means, more commonly referred to as the House Ways and Means Committee, is one of 29 U.S. House of Representative committees and is the chief tax-writing committee in the U.S. The House Ways and Means Committee has jurisdiction over all bills relating to taxes and other revenue generation, as well as spending programs like Social Security, Medicare, and unemployment insurance, among others. Chairman Kevin Brady floated the idea of a five-year phase-in for the border adjustment. The border adjustment is a key piece of the House GOP’s proposal to replace the corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. with a 20 percent “destination-based cash-flow taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. ” (DBCFT). The border adjustment would apply the federal income tax to imports, but exempt exports. This change would improve business taxation, especially regarding international taxation. It would essentially eliminate the type of profit shiftingProfit shifting is when multinational companies reduce their tax burden by moving the location of their profits from high-tax countries to low-tax jurisdictions and tax havens. that occurs under current law and it would allow for the elimination of current complex international tax rules, which would simplify the tax code.

While the proposal would make several improvements to the tax system, it has come up against political resistance from a few industries, such as retail. They believe that applying the tax to imports will drive up their costs, eat into their profits, and increase consumer prices. Economists generally disagree and argue that the dollar would appreciate relative to other currencies, keeping the after-tax dollar cost of imports and exports unchanged.

In response to these concerns, Brady has proposed phasing in the border adjustment steadily over five years. In the first year, imports would only receive an 80 percent deduction. The next year a 60 percent deduction and so on until the deduction for imports is fully phased out. The same phase-in would apply to the export exemption.

The aim of the five-year phase-in is to address many importers’ concerns that this provision would be disruptive. Importers don’t necessarily believe the dollar will appreciate fast enough to offset the additional tax liability. And, even if the dollar did appreciate, some imports are priced in dollars and set in contracts, meaning their prices may not adjust as quickly as the dollar does.

Adding a phase-in would lessen some concerns, but it could introduce downsides.

1. A phase-in would alleviate concerns about fixed dollar contracts.

Importers have a number of concerns with the border adjustment. Most of their issues with the policy come from their suspicion of the economic theory that the border adjustment is trade-neutral. However, one of their concerns is a legitimate issue with respect to transition. Specifically, many imports are priced in dollars and set in long-term contracts. This means that, even if the dollar appreciates immediately, some importers would be faced with a higher tax bill until their existing import contracts expire.

Allowing for a phase-in provides time for those contracts to expire and for companies to adjust new contracts to the stronger dollar. A phase-in is also more in line with the approach that most countries took when introducing their VATs. VATs are levied at rates as high as 27 percent in Europe and apply to imports (and exempt exports), but those rates were phased in in stages.

2. A five-year phase-in would reduce the amount of revenue the border adjustment would raise over the next decade.

According to our latest estimates, a border adjustment, enacted in full at a 20 percent rate, would raise about $1.24 trillion over the next decade. If the proposal is phased in steadily over five years (20 percent per year), this would reduce the amount of revenue this provision would raise by about $220 billion over a decade (Table 1). This would require other offsets to keep the plan revenue-neutral over the budget window. For example, the law could phase in rate cuts, or just deal with a slightly larger budget deficit in the first few years.

Table 1. Revenue Impact of 20 percent Border Adjustment with and without Phase-in (Billions of Dollars)
Source: Tax Foundation Taxes and Growth Model.
Notes: Assumes five-year phase-in at 20% for both import tax and export exemption. Analysis does not account for potential behavior changes or changes in aggregate economic activity.
2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2017-2026
Immediate Border Adjustment $104 $108 $112 $116 $121 $126 $131 $136 $142 $147 $1,244
5-year Phase-in $21 $43 $67 $93 $121 $126 $131 $136 $142 $147 $1,028

However, it is important to note that the border adjustment would end up raising the same amount in the long run, because a phase-in would only impact revenue collections in the first five years. This is important to remember when thinking about the plan’s interaction with reconciliation and the Byrd Rule.

3. A phase-in would create short-term winners and losers.

A direct impact of the border adjustment is that the dollar would appreciate to the point that the tax on imports and the exemption on exports would be completely offset. Currency markets react quickly to changes in policy (in fact, currencies often react in anticipation of policy changes). As such, it is very likely that the dollar would immediately appreciate to offset the border adjustment, whether it is enacted immediately or phased in.

If the border adjustment is phased in over time, currency traders know that a policy sometime in the future will cause the dollar to appreciate by 25 percent. They will want to purchase as many dollars as possible to profit from that appreciation and thus push the dollar up quickly.

As a result, it is likely that the U.S. dollar would appreciate much faster than the border adjustment phases. The downside of this is that it would create winners and losers during the phase-in period. Importers would be happy about this. The dollar would be 25 percent stronger, making their imports cheaper, but they would not face the full 20 percent border adjustment for a few years. Exporters would not be happy about this arrangement. Their goods would be 20 percent more expensive on the world market and they would not get a tax exemptionA tax exemption excludes certain income, revenue, or even taxpayers from tax altogether. For example, nonprofits that fulfill certain requirements are granted tax-exempt status by the Internal Revenue Service (IRS), preventing them from having to pay income tax. to fully offset that disadvantage for a few years.

For someone who thinks the border adjustment would result in an immediate dollar appreciation, a phase-in is unnecessary. However, for those skeptical of immediate dollar appreciation, this proposal acts a bit like insurance for importers, paid for by exporters. Exporters are basically paying to insure importers against the risk that the dollar doesn’t appreciate enough.

Phasing in the border adjustment isn’t perfect (no policy is) and would create some issues in the process of solving others. However, ultimately, the policy would end up in the same place: a reform that makes meaningful improvements to the way the U.S. taxes businesses.