There’s been a lot of talk recently about the “border adjustment,” a proposed change to the U.S. 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. system that is part of the House GOP Blueprint. At the Tax Foundation, we’ve been getting a lot of questions about how a border adjustment would work and what it would do to the U.S. economy. So for your convenience, here is a handy guide that answers your questions:
What is a border adjustment?
The border adjustment is a way of modifying the current U.S. income tax. Right now, the income tax applies to businesses’ income from production in the United States. Under a border adjustment, the income tax would apply to businesses’ income from sales in the United States.
How would a border adjustment work?
Right now, if a company makes a product in the United States and sells the product overseas, it is required to pay income taxes to the U.S. on the income from the sale. But under a border adjustment, companies would no longer be required to pay income taxes to the U.S. on their income from exports – because the products are not sold in the United States.
On the flip side, under the current tax code, if a company sells a product in the United States that was produced overseas, it doesn’t pay income taxes to the U.S. on the value of the imported product. But under a border adjustment, companies would be required to pay income taxes to the U.S. on the value of their imports – because the products are sold in the United States.
In total, under a border adjustment, the income tax would apply to goods produced and sold in the United States and goods produced in foreign countries and sold in the United States.
Would a border adjustment raise prices for U.S. consumers?
From the description above, it might sound like a border adjustment would raise taxes on imported products, creating higher prices for consumers. However, economists think that a border adjustment would also lead to a much stronger U.S. dollar, which would make it cheaper to import goods, and would cancel out the higher taxes on imports. Even so, some are concerned that exchange rates won’t fully adjust to offset the tax; in this case, prices on imports for consumers may rise in the short run, but eventually all domestic prices and wages would rise in kind. Overall, there is little reason to think that a border adjustment would raise prices for consumers in the long run.
Why do economists think that a border adjustment would lead to a stronger dollar?
By exempting exports from U.S. taxes, the border adjustment would initially create higher demand for U.S. goods and U.S. dollars. At the same time, by taxing the value of imported products, the border adjustment would initially create lower demand for foreign goods and foreign currencies. Together, these two effects would cause the value of the dollar to rise significantly.
Would a border adjustment hurt U.S. companies that import foreign products? Would it help U.S. exporters?
A border adjustment is trade neutral. At first glance, it would seem that a border adjustment would raise taxes on U.S. companies that import foreign products. However, the stronger U.S. dollar would also make it significantly cheaper for these companies to buy foreign goods and services. Under the standard economic theory, the rise in the U.S. dollar would offset the higher taxes on these companies, leaving importers unharmed in the long run.
Similarly, it would seem that a border adjustment would lower taxes on U.S. companies that export their products. However, the stronger U.S. dollar would also make it more expensive for foreigners to buy U.S. exports. Under the standard economic theory, the rise in the U.S. dollar would offset the lower taxes on U.S. exporters, leaving them in the same position as before.
Would the dollar actually adjust quickly enough to make this all work?
There is evidence that currency markets react very quickly to expected U.S. policy changes, such as the rapid swings in the value of the Mexican peso during last fall’s presidential campaign depending on how well Trump was doing relative to Clinton. More broadly, over 140 countries have a border-adjusted tax, and academic literature dating to the 1950s has shown why currencies would adjust. In addition, there is circumstantial evidence from the United Kingdom, which raised its border-adjusted, value-added tax in 1979, 1991, and 2010, that currency adjustments happen quickly after proposed changes are announced. However, even if currencies adjust quickly, some factors may slow the speed at which import prices adjust to those changes, including the fact that many goods are priced in dollars internationally.
Is the border adjustment the same thing as a tariffTariffs are taxes imposed by one country on goods or services imported from another country. Tariffs are trade barriers that raise prices and reduce available quantities of goods and services for U.S. businesses and consumers. ?
A border adjustment is not a tariff. A tariff is a tax on products from foreign countries, while a border adjustment is a comprehensive reenvisioning of how the U.S. income tax works. Moreover, tariffs lead to higher prices for U.S. consumers and reduce trade; by contrast, a border adjustment is not expected to increase U.S. prices in the long run or lead to lower trade.
Is the border adjustment the same thing as a “border tax”?
The Trump administration talks a lot about the idea of a “border tax,” but it’s not always clear exactly what they mean. Sometimes, the administration seems to be talking about a tariff on foreign imports, while other times, they use “border tax” to refer to a targeted tax on companies that outsource U.S. jobs. Both of these proposals are different than a border adjustment. Overall, it’s probably best to identify the “border tax” as a category that includes several somewhat related tax proposals; in contrast, the border adjustment is a specific proposal that has been offered by House Republicans.
Would a border adjustment have any effect on the U.S. trade deficit?
Some lawmakers have claimed that implementing a border adjustment would help reduce the U.S. trade deficit, but this is incorrect. Because the border adjustment would neither aid exporters nor hurt importers, it should have no effect on trade levels in the long run.
If the border adjustment isn’t expected to have any effects on the trade deficit, then why do it?
There are at least three good reasons to implement a border adjustment:
To raise revenue in the least distortive manner, in order to lower overall rates for U.S. taxpayers
The Tax Foundation estimates that, in the context of the House GOP tax plan, the border adjustment would raise $1.1 trillion over 10 years, and would do minimal economic harm. This revenue would go toward lowering 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. rate from 35 percent to 20 percent. Without the revenue from the border adjustment, the proposed corporate tax rate would have to rise to 27 percent to keep the cost of the plan the same.
To protect the U.S. tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. by improving business incentives
Every tax system needs measures to prevent companies from avoiding taxes, and the border adjustment is the main provision that accomplishes this in the House GOP tax plan. By changing the system from taxing companies based on where they produce to based on where they sell, the border adjustment would greatly reduce businesses’ incentives to move their operations and headquarters to low-tax countries, use transfer pricing to shift income abroad, and move intellectual property to tax havens.
To simplify the business tax system
Currently, U.S. businesses spend $150 billion a year complying with the U.S. tax code, much of that devoted to navigating the complex set of provisions that deal with income earned overseas. The border adjustment would replace most of these complicated international tax ruleInternational tax rules apply to income companies earn from their overseas operations and sales. Tax treaties between countries determine which country collects tax revenue, and anti-avoidance rules are put in place to limit gaps companies use to minimize their global tax burden. s.
Is the border adjustment a tax hike on consumers?
Some advocacy groups have characterized the border adjustment as a tax increase on consumers. However, this is incorrect. Because the border adjustment is not expected to raise prices in the United States in the long run, the burden of the provision would not fall on U.S. consumers.
Furthermore, it does not entirely make sense to talk about the border adjustment as a tax increase, because it has been proposed in the context of the broader House GOP tax plan, which is a $2.4 trillion tax cut for U.S. taxpayers.
If the border adjustment doesn’t raise taxes on consumers, where does the revenue come from?
The basic reason why a border adjustment raises revenue for the federal government is that businesses currently sell more in the United States than they produce here. By taxing companies on their income from sales in the United States, rather than their income from production, the border adjustment would apply to a broader base of income, and would raise more revenue.
However, as described above, the burden of the border adjustment is not expected to fall on U.S. businesses, because the border adjustment would cause the U.S. dollar to rise in value, offsetting the higher taxes on importers and the lower taxes on exporters.
So who bears the burden of the border adjustment, then?
Ultimately, the burden of the border adjustment would fall on U.S. individuals and businesses that own foreign assets. Because the border adjustment would lead to a stronger U.S. dollar, it would become more expensive for these individuals and businesses to convert their foreign profits into dollars. As a result, the border adjustment is a tax change that falls more heavily on the wealthy.
The border adjustment sounds complicated. Would it really make the tax code simpler?
While some people may find the mechanics of the border adjustment difficult to understand, it will probably turn out to be much less complicated than the byzantine tax rules that currently govern businesses today. The border adjustment would eliminate the need for firms to comply with our complex rules governing controlled foreign corporations (CFCs), passive foreign income (Subpart F), transfer pricing, interest allocation, foreign tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. s, and accounting for deferred taxes. Under a border adjustment, all companies would need to account for is what items they purchase from abroad and what products they send abroad.
The fundamental reason why a border adjustment would simplify the tax code is because it is much easier to define where a company’s sales occur than where its production occurs. If a company produces 200,000 cars using a supply chain that stretches over 12 countries, it is nearly impossible to define how much of the cars’ value was produced in the United States, but much simpler to track how many of the cars were sold in the United States.
What are some drawbacks of the border adjustment?
Every tax policy proposal has benefits and drawbacks, and the border adjustment is no exception. One potential drawback of the House GOP’s proposed border adjustment is that it may violate the rules of the World Trade Organization, which does not always allow member countries to make their taxes border-adjusted. As a result, the border adjustment could create some business uncertainty until the WTO makes a determination about its validity. In addition, if the House GOP plan were passed, other countries might retaliate against the United States with anti-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. and anti-tax haven legislation, in order to stop foreign companies from shifting their profits into the United States.
Another potential drawback of the border adjustment is that if it is not carefully designed, it may end up disadvantaging certain exporters, who would not receive a full tax rebate on their exports, but would still be hurt by the stronger dollar. It will also be challenging to make sure all imports and exports, including services, are subject to the tax because the location of services are sometimes hard to define. Finally, lawmakers have not yet clarified how the border adjustment will apply to direct sales from foreign businesses to U.S. individuals, which is an important policy design question that needs to be answered before a bill can be passed.
Where can I learn more about the border adjustment?
The Tax Foundation has published several pieces discussing the details of the border adjustment, including:
- The House GOP’s Destination-Based Cash Flow Tax, Explained
- Exchange Rates and the Border Adjustment
- A Destination-Based Business Tax is Not the Same as a Territorial Business Tax
- What is the Distributional Impact of a Destination-Based Cash-Flow Tax?
In the coming weeks, the Tax Foundation will be publishing a longer paper about the border adjustment. Stay tuned!
[2/13: Edited for clarity and some additional content.]Share