Skip to content

Border Tax Adjustments and Fundamental Tax Reform

3 min readBy: William P. Orzechowski

Download Paper No. 39

Executive Summary
Fundamental 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. reform, whether in the form of a flat taxAn income tax is referred to as a “flat tax” when all taxable income is subject to the same tax rate, regardless of income level or assets. , consumed income tax, or national sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. , promises to greatly improve economic prosperity and eliminate much of the complexity and associated compliance costs of the current system. Supporters also make the case that fundamental tax reform has the potential to increase American business’s competitiveness in international markets through the use of border tax adjustments (BTAs).

BTAs are one mechanism through which a “tax neutral” setting for international trade and economic competition can be established. The government accomplishes tax neutrality by rebating taxes on exports and applying taxes to imports. The General Agreement on Tariffs and Trade, which defines the scope of international BTAs, only recognizes consumption taxA consumption tax is typically levied on the purchase of goods or services and is paid directly or indirectly by the consumer in the form of retail sales taxes, excise taxes, tariffs, value-added taxes (VAT), or an income tax where all savings is tax-deductible. es or those taxes applied directly to goods and services as eligible for BTAs. This means the Value Added Tax (VAT), sales, and excise taxes are BTAeligible but income, social insurance, and other direct taxA direct tax is levied on individuals and organizations and cannot be shifted to another payer. Often with a direct tax, such as the personal income tax, tax rates increase as the taxpayer’s ability to pay increases, resulting in what’s called a progressive tax. es are not. In theory, European businesses are at a competitive advantage vis-à-vis their American counterparts because European countries impose a consumption- based tax on domesticcompanies while the United States government imposes an income-based tax. European companies, therefore, can make use of BTAs while American businesses cannot.

All three types of fundamental tax reform considered over the past few years— the national sales tax, the flat tax, and the unlimited savings allowance tax—would move the U.S. toward a consumption-based tax system and therefore into greater alignment with European trading partners. Each of these variants would have different consequences in terms of the practicality of BTAs. BTAs would be most compatible with both the USA tax and the national sales tax because of their consumption-based approach. They would be least compatible with the flat tax, although some make the case that the flat tax on business could be eligible for BTAs.

Economists traditionally have taken an agnostic view of BTAs, despite their political popularity, because the natural dynamism of prices, especially exchange rates, effectively creates a tax-neutral trading environment without the need for BTAs. This is essentially true regardless of the form that fundamental tax reform takes or whether BTAs are included or not.

Admittedly, there would be a transition period during which time the presence or absence of BTAs will affect the competitiveness of firms. The question then is whether the short-term, transitional benefits would be worth the cost of administering and complying with BTA. Most economists would answer no, especially because the presence of BTAs tends to mask the true cost of corporate taxes thus making corporate representatives and lawmakers less sensitive to tax increases.

This suggests that the merits of a particular tax reform model should be judged primarily by other criteria. Much more important than border adjustability is how tax reform would improve underlying economic incentives, such as rewarding risk, savings, and investment, which in turn would boost productivity. There has never been much of a mystery on this score. Eliminating the double tax that currently exists on savings and investment and reducing rates in general would spur economic growth and make U.S. companies much more competitive in the world market. Border adjustability is not likely to have a great deal of impact on the competitive position of U.S. businesses in world markets.