Why just saying ‘no’ to the border adjustment tax will not work

Let’s get this over with: the House leadership tax plan is certainly not perfect and, within it, the border adjustment tax will not solve America’s trade problems. There are important debates to be had on topics from income distribution to pass-through entities. But there are also strange things said about tax reform in general and border adjustment in particular that should be set aside.

A party in control of the White House and Congress presumably wants to take the opportunity to make profound change. One area where there is strong agreement that the U.S. badly needs such change is corporate taxes. Sound corporate tax reform can spur growth and improve America’s global competitiveness.

{mosads}Lower corporate tax rates would help. But with debt already high, just lowering rates risks having the federal deficit jump and taxes ultimately raised again. Much lower corporate tax rates by themselves are neither sustainable nor much of a “reform.”

The border adjustment tax (BAT) offers a way to turn tinkering with rates into a far more powerful economic boost. With a BAT, corporate tax rates can be sharply cut. Moreover, the BAT perfectly fits the nature of the proposed reform, recognizing that corporations have global options and encouraging them to locate and hire in the U.S.

BAT opponents need to do more than object, they should offer a replacement. No BAT and no replacement means fiddling with — rather than fixing — taxes, and a Republican majority that is unlikely to stay a majority.

On the trade side, there are also more and less reasonable issues pertaining to the BAT. The starting point is how exchange rates will respond. There are questions about how well economic models represent the real world here, especially since the U.S. dollar is the world’s reserve currency, not comparable to any other.

In most economic models, applying the tax without changing fundamentals does not change buying power. In simple terms, the core features of the American economy do not immediately change with a BAT. So, if imports are made more expensive, the dollar should immediately rise to make them cheaper and maintain the same prices as before.

If the dollar does not rise fully or quickly, the BAT will make imports more expensive and exports cheaper, shrinking the trade deficit. This matters. But it is generally agreed the effect will fade and American trade will be less influenced over time by the BAT. If the US continues to run a trade deficit, the BAT will essentially tax that deficit and provide steady revenue.

Other questions are based on motives. Some legal analysts note the World Trade Organization (WTO) does not specifically allow a BAT, so other countries could win rights to retaliate against it. This is based at least as much on the fact that the BAT is new, and therefore suspicious, as on the details of the House leadership’s proposed framework.

Our trade partners will certainly complain, but retaliating would be a mistake on their part and the part of the WTO. The BAT is a component of domestic tax reform. It is economically equivalent to several combinations of domestic tax changes that the WTO would have no jurisdiction over.

If the BAT is passed and exchange rates largely adjust — admittedly two things yet to happen — a WTO challenge would be aimed at a reform supported by the President and Congress which has vital domestic effects and arguably is not a WTO concern at all. Meanwhile, the WTO fails miserably to address global subsidies which directly discourage imports, as an example.

The WTO rejecting the BAT would be poorly justified and risky. Individual countries are in the same position. Many American partners have long applied value-added taxes and other trade-related fiscal practices that, in combination, are similar to the BAT. It would not be easy for them to point to harm from the BAT without indicting their own practices.

Our top trade partner last year, China, is also likely to speak loudly but wield no stick. China dislikes the BAT but dislikes global retaliation for internal economic choices even more. As long as the BAT does not specifically target China, Beijing will grumble, hope others take the lead, and itself remain on the sidelines.

The one way for individual countries to have a stronger case, and the WTO to find against the U.S., is such targeting. Right now the BAT proposal does not treat countries or goods and services differently through exemptions and the like. Singling out certain products for special treatment would give our partners strong reasons to object and must be avoided.

The words “border adjustment” and “irony” usually aren’t used together. If the BAT fails, corporate tax reform will be much shallower. The economy and, in particular, hiring will see little or no boost. And pressure for true protectionism, the kind many BAT opponents say they want to avoid, will rise further. Be careful what you wish for.

Derek M. Scissors is a resident scholar at the American Enterprise Institute and author of, among other things, the China Global Investment Tracker.

The views expressed by contributors are their own and are not the views of The Hill.