Border tax adjustments

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Border Tax Adjustments

The Key to US Competitiveness

Presented by David A. Hartman of The Lone Star Foundation with the assistance of IAS Group

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Overview

I will be addressing 3 main points.

First – the serious state of our US manufacturing sector and the similar prospects for business services;

Second – the ways the IRS Code is at the root cause for this state of affairs; and

Third – what can be done to remediate the tax code to enable a return to growth and prosperity of US manufacturing and business services.

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Background

Following WWII, the US led the movement toward the end of protectionism and the prevention of war.

As a consequence, the GATT established general rules of fair trade, which progressively lowered industrial country tariffs from 40% to a current average of 3-4%

Other rules were created to establish a level playing field for all members. The one which has caused difficulty for the US tax system is the subsidy rule on border tax adjustments

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Taxes - The #1 US Trade Problem

The WTO differentiates between direct and indirect tax

Rebate of direct taxes (such as on income) is deemed illegal export subsidy

Indirect taxes levied on imports and rebated on exports (such as value added taxes) are deemed legal

TYPE EXAMPLE BORDER ADJUSTABLE?

DIRECT

(on income)

PAYROLL

PERSONAL INCOME

CORPORATE TAXES

DISC, FSC, ETI

(not border adjustable)

NO = SUBSIDY

INDIRECT

(on consumption)

BUSINESS TRANSFER TAX

VALUE ADDED

RETAIL SALES TAX

(all border adjustable)

YES = NO SUBSIDY

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How BTAs Work

Exporter receives rebate of the tax at border

Importer must pay tax at border

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Impact on Relative Prices

UNITED STATES

Local Price: $100

Starting price of good in US – a non-BTA country

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United StatesLocal Price: $100

GermanyLocal Price: $100

Standard VAT Rate: 16%

US Export/Import to/from Germany

Result: US exporters are penalized by a factor of $16.00 when exporting to Germany

US producers are penalized by a factor of $13.79 on imports from Germany

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United StatesLocal Price: $100

MexicoLocal Price: $100

Standard VAT Rate: 15%

US Export/Import to/from Mexico

Result: US exporters are penalized by a factor of $15.00 when exporting to Mexico

US producers are penalized by a factor of $13.05 on imports from Mexico

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MexicoLocal Price: $100

Standard VAT Rate: 15%

GermanyLocal Price: $100

Standard VAT Rate: 16%

Export/Import to/from BTA Countries

HOWEVER, when trade occurs between two countries with BTAs – some or ALL of the penalty disappears

But as you can see, the country with the higher BTA still provides a relative advantage for its domestic producers

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What this means . . .

Currently, US exporters of goods/services receive NO rebate of any US tax paid at the border and are taxed when entering a foreign market – thereby DOUBLE taxing the US export

By choosing NOT to levy any tax on imports, the US effectively subsidizes all imports

When competing with foreign goods, whether in the US or in international markets, US producers are placed at a severe disadvantage by the US tax code

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Surge of BTAs Worldwide

Since WWII, over 125 countries have adopted some form of legal Border Tax Adjustment (BTA)

All Organization for Economic Co-operation and Development (OECD) countries EXCEPT the US have BTAs

The average OECD BTA is 17.7%

The range of BTAs is 10-25%

0

20

40

60

80

100

120

140

1960 1968 1976 1984 1992 2000

Number of countries with BTAs by year

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The Bottom Line

Since the late 1960s, US Manufacturing share of GDP has declined by 50%

The US currently has a trade deficit with almost EVERY trade competitor in almost EVERY CLASS of goods. The US only produces $2 of every $3 of goods it consumes, and only $1 of every $3 of information technology goods (EDP and telecommunications)

US Manufacturing has lost over 3.5 million jobs since

1998

Growth of outsourcing threatens loss of service-based jobs as well

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The Answer

To restore American competitiveness, any tax reform must (a) incorporate a border adjustable tax; and (b) shift all or most of the tax burden from income and to consumption

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BTAs in America – How would they help?

BTAs are the SINGLE largest measure to correct the unsustainable trade deficit – ensuring reciprocal tax treatment for US imports and exports

BTAs are levied on all imports and rebated on all exports

Rebates on exports are not reserved solely for large exporters, but are a right for all

BTAs are WTO compliant BTAs are free trade consistent BTAs will reduce American

dependence on foreign financing and promote domestic saving for investment

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What we propose

REPLACE (not add onto) current federal income taxes, with a consumption based BTA

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Types of Border Adjustable Consumption Taxes Retail Sales Tax

Credit Invoice Value Added Tax (similar to European VAT)

Subtraction Method Business Transfer Tax (BTT) **

Proponents argue for a 23% rate to replace all other taxes. As exemptions are made, the tax must rise, therefore realists advise a 30% rate.

Collected on every transaction – requires extensive record keeping. Complex and burdensome.

Simplified form of VAT. Requires standard corporate financial records. All businesses would pay, evasion difficult and ALL capital investment could be expensed

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Possible Options for Adoption of Consumption BTT

Option 1: 17.5% BTT which Sunsets IRS Code Replaces ALL federal income, capital and

personal taxes (except for employees’ share of Social Insurance and Medicare)

Pays transition costs

OR

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Option 2 – Phase in

Step 1: 5.25% BTT whichReplaces corporate

income tax, corporate welfare expenditures, employer social insurance taxes and inheritance and gift taxes

But keeps other taxes same

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Option 2 (continued)

Step 2Raise BTT to 11% Drop personal income tax to FLAT 11%, keeping

current deductions allowed by CodeStep 3

Raise BTT to 17.5% whichSunsets IRS Code Replaces ALL federal income, capital and

personal taxes (except for employees’ share of Social Insurance and Medicare)

Pays transition costs

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BTT – A Fair Solution

Corporations will be assured the benefit of unused depreciation and lost carryovers

A consumption tax ends double taxation of dividends and promotes saving for investment

The individual taxpayer chooses how much and when he pays tax – i.e. only pay tax on what taxpayer consumes

To address regressivity, individual taxpayers could be reimbursed the BTT on necessities, etc.

“Hybrids” have been suggested which would be better than the current code (e.g. a reduced BTT with a retail sales tax, etc.)

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Summary

A border adjustable consumption tax MUST BE a component of any reform of the US tax system 

BTAs would substantially reduce the trade deficit and provide a powerful incentive for Americans to save, invest, produce, and export

The border adjustable tax should replace and not be added to existing income and capital taxes

The tax changes should also ensure that low income persons are not disadvantaged

ANY BTA would be an improvement, but the BTT is the best alternative

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Appendix

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Failed US Response

Three times in the last 30 years the US has amended the tax code to provide a tax subsidy to selected exports – the DISC, FSC and ETI

ALL were found to be ILLEGAL rebates (subsidies) of direct taxes under the WTO and had to be repealed

Even when in effect, NONE of them could be applied to imports

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Failed US Response

Any income tax rebate will face same legal problems at the WTO

In the WTO Doha round, the US is seeking to obtain equal treatment for direct/indirect taxation. In effect, the US aims to convince 125 other nations to abandon their beneficial BTAs – this is hopeless.