Now that White House press secretary Sean Spicer has inadvertently ignited a firestorm by suggesting that President Trump wants to pay for a border wall by imposing a 20% border tax on Mexican imports, and cable news hosts are gravely discussing the impact of such a tax on the price of guacamole, and the Koch brothers are waging war against it—in short, now that the topic has become an incomprehensible mess—it’s time to step back, breathe deeply, and come to grips with it.
What everyone is talking about, whether they know it or not, is the House Republicans’ proposed corporate tax reform, announced last June. It says absolutely nothing about imposing a 20% border tax. Here’s what it does say, and why it’s being regarded as a border tax, and why that’s a highly incomplete view of it.
One of the plan’s features is that it’s “destination based” with “border adjustment,” meaning that it taxes only economic activity in the United States. So when a U.S. Company sells goods or services overseas, that revenue is ignored—not subject to U.S. Tax at all. By the same token, when a U.S. Company buys goods or services overseas, that expenditure is also ignored—and is therefore not a deductible expense for U.S. Tax purposes. Now combine that feature with another part of the House GOP plan, which lowers the corporate tax rate from 35% to 20%. The result is that when a U.S. Company buys avocados from Mexico, or anything from anyplace outside the U.S., it can’t deduct the expense on its U.S. Tax return, but a company buying the same thing within the U.S. Can deduct the expense; so the first firm effectively pays 20% more than the second. That’s where all the talk about a 20% border tax comes from, and why so many talking heads are saying it would help exporters and hurt importers.
But that’s only half the story, and the second half is generally skipped, especially on TV. Economists argue that under such a tax regime, the value of the dollar would immediately rise—foreigners would stampede to buy dollars in order to snap up U.S. Exports, which would momentarily drop in price—until the dollar’s rise offset the new tax effects. Importers would be no worse off because the dollar’s greater buying power would just balance their new tax disadvantage, so—if you believe the economists’ models—your imported avocados (or anything else) wouldn’t cost any more at all. For exporters, the stronger dollar would likewise nullify their new tax advantage, so they’d be no better off. Bottom line: The so-called 20% border tax would not do what most of the TV commentators say it would.
Sound complicated? It does to most people, especially since the treatment of imports and exports is just part of the GOP’s proposed corporate tax reform; the other main part concerns the tax treatment of investment and borrowing. But it seems bewildering only because it’s so radically different from the current regime. As a whole, it’s dramatically simpler. For a compact explanation, see this from the nonpartisan Tax Foundation, or this column yesterday by Harvard economist Martin Feldstein. And if you really want to understand what motivates these ideas in the first place, read this paper by U.C. Berkley professor Alan J. Auerbach, who inspired the GOP plan with his proposal a few years ago.
That’s a lot of reading about tax policy. But it’s the only way to understand a potential once-a-generation tax reform that you’ll be hearing much more about—the pundits probably won’t help you.
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