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

Shipping transport

laughingmango/E+/Getty Images

The border adjustment tax (BAT) earned its share of headlines 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 which 140 other countries impose—in 1997. Ultimately, Congress failed to push the tax through due to heavy opposition, but that could change. 

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. 

Of course, nothing’s ever that simple when it comes to business taxes. The BAT also prohibits tax deductions for goods brought into the U.S. for the purpose of manufacturing other products.

As an example, let’s say that 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 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 manufactured 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 a balanced effect on trade because exports are not taxed. If XYZ also sells some of its robots in Canada, that portion of its sales would escape the BAT. 

As the law stands now, the U.S. imposes an origin-based tax which works the opposite way. The tax applies to the production of goods manufactured in the U.S. Profits are taxed where they’re earned. Under current tax law, XYZ’s Canadian sales would be subject to the tax. 

The Goal of the Border Adjustment Tax 

It begs asking—why make such a significant change? As stated by those who supported the BAT, the goal is that it should 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 if they stay on U.S. soil, it will create more American jobs

Proponents have said that implementing the tax would raise something in the neighborhood of $1 trillion over ten years. The Tax Foundation puts the number at closer to $1.1 trillion. U.S. businesses have historically sold more in the U.S. than they’ve produced here. 

That much money would nicely offset the expected deficit that would result from slashing corporate tax rates, a proposal that was also on the Congressional to-do list at the time the BAT was being debated. 

Arguments Against the BAT

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

It would affect taxpayers who aren’t unemployed or looking for a job, who are collecting paychecks but who must now spend more of those paychecks 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 tax 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 say that the tax would increase inflation as the cost of imported goods and parts goes up. 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 Now?

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 to 20 percent. 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 included the BAT. 

But the tax’s demise might not be a done deal. President Trump indicated in February 2018 that he might propose another similar version of the BAT. Politico has indicated that he has very little in the way of Congressional support, however.