The Border Adjustment Tax: How It Works and Who It Affects

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The border adjustment tax (BAT) earned its share of headlines back in 2017 as Congress began gearing up to pass tax-reform legislation. It’s a destination-based cash-flow tax similar to a value-added tax.

Economist Alan A. Auerbach is credited with coming up with the BAT—a version of tax that 140 other countries impose—in 1997. Ultimately, Congress failed to push the tax through due to heavy opposition.

How the Border Adjustment Tax Works

The basics of the BAT are really pretty simple: Imported goods that are sold in the U.S. are taxed. Goods exported from the U.S. are not. The whole premise is to tax goods based on where they’re “consumed” or enjoyed, not as they’re flowing out to other countries.

It doesn’t matter where a company is based or headquartered. It all comes down to where its products are sold. 

The BAT also prohibits tax deductions for goods brought into the U.S. for the purpose of manufacturing other products.

Suppose XYZ Company manufactures housecleaning robots. The robots require a certain computer chip that tells them when it’s time to mop your floor. XYZ Company purchases these chips from a source in Taiwan. It then assembles its robots and sells them to consumers in the U.S. 

Because U.S. buyers purchase the robots, the money they bring in for XYZ Company is subject to the BAT and is taxed. This would be the case even if XYZ were to manufacture its robots in another country where labor might be cheaper, not actually on U.S. soil. XYZ Company cannot deduct the cost of the chips as a business expense either. 

Theoretically and in the long run, it’s anticipated that these rules would have had a balanced effect on trade, because exports aren't taxed. That portion of sales would escape the BAT if XYZ also were to sell some of its robots in Canada.

The U.S. imposes an origin-based tax as of 2020, and this works the opposite way. The tax applies to the production of goods manufactured in the U.S. Profits are taxed where they’re earned. XYZ’s Canadian sales would be subject to the tax under 2020 tax law. 

The Goal of the Border Adjustment Tax 

Why make such a significant change? The goal was that it would strengthen the U.S. dollar and that this, in turn, would eventually cut the cost of imported goods. 

Manufacturers would additionally be deterred from increasing their profits by purchasing cheaper parts from other countries. The BAT would discourage U.S. firms from establishing locations in other, low-tax countries as well, then selling what was produced there to U.S. consumers. And it would create more American jobs if they were to stay on U.S. soil.

Proponents have argued that implementing the tax would raise something in the neighborhood of $1 trillion over 10 years. The Tax Foundation put the number at closer to $1.1 trillion in 2017.

U.S. businesses have historically sold more in the U.S. than they’ve produced here. 

That much money would nicely offset the deficit that might yet result from slashing corporate tax rates, which happened in 2018 when the Tax Cuts and Jobs Act (TCJA) reduced the rate to 21% from 35%.

Arguments for and Against the BAT

The biggest push against implementing a BAT is that the tax would trickle down to U.S. consumers. Companies would effectively pass the tax onto them. A BAT would raise prices for consumers even as it produced more jobs, making it something of a wash.

The tax would affect taxpayers who were collecting paychecks but would have to spend more for everything from automobiles to clothing to those robotic maids. Numerous American businesses immediately cautioned that they would raise their prices in response if the BAT were implemented.  

The argument in favor of the BAT is that this effect would not last forever. It would balance out in the long-term, and wages would rise as well. But taxpayers can’t be blamed if they don’t want to wait for relief. 

Opponents claim that the tax would increase inflation as the costs of imported goods and parts would rise. Exports could be expected to decrease, because a stronger dollar would make it more expensive for other countries to buy from the U.S. 

Where Does the BAT Stand?

Republicans first launched the idea of Auerbach’s version of the BAT in 2016. They did it hand-in-hand with their proposal to cut the corporate tax rate. By early 2017, the tax was the subject of hot debate among legislators and lobbyists alike.

House Speaker Paul Ryan (R-Wis.) ultimately threw his hands up in defeat in July. House Ways and Means Committee Chairman Kevin Brady (R-Tex.) had also supported the tax, and he backed off as well. The Republican Party was divided, or at least ambivalent, on the issue, because it seemed apparent that their overall tax reform package wouldn’t pass if it were to include the BAT.