Border adjustment tax plan not likely to survive
President Trump last Thursday said that he would announce “something phenomenal in terms of tax” over “the next two or three weeks.” The markets suspect that Mr. Trump was referring to his Feb 28 speech to Congress for an announcement since the timing lines up. In any case, the stock market last Thursday took off and never looked back from Mr. Trump’s mere mention of a “phenomenal” tax plan.
By all accounts, Gary Cohn, current National Economic Council director and former Goldman Sachs president and COO, is leading the Trump administration’s effort to develop a tax plan. He has been consulting closely with House Republicans.
The Trump tax plan will likely include key elements of the House Republicans’ plan, which involves a cut in the corporate tax rate to 20% from 35%, a low 8.75% tax on the deemed repatriation of the $2.6 trillion in U.S. corporate profits that are parked overseas, a border adjustment tax plan with a 20% tax on imports, dropping the deductibility of interest, and allowing the immediate expensing of capital investments, among other items.
There is little doubt that the final legislation that gets through Congress will include a cut in the corporate tax rate and a low one-time tax on repatriated profits that will help bring in some offsetting revenue. However, the big question is whether the final Trump/Republican plan will include the border adjustment tax system. Without the estimated $1.1 trillion in revenue over ten years from the border adjustment tax system, Republicans will not be able to cut the corporate tax to as low as 20% from the current 35%. In fact, the Tax Foundation estimates that the corporate tax could be cut to only 27% without the border adjustment revenue.
Republicans plan to push the corporate tax plan through Congress using the reconciliation process, which eliminates the ability of Senate Democrats to filibuster. However, getting the border adjustment tax system through the Senate will not be easy since Republican leaders can afford to lose only three Republican Senators due to their narrow 52-48 majority (VP Pence can break a 50-50 tie).
Two of the three Republican Senators needed to oppose the plan have already become known. Senator David Perdue (R-GA) last week sent a letter to his fellow Senators urging them to reject the border adjustment tax, saying, “This 20% tax on all imports is regressive, hammers consumers, and shuts down economic growth.” Senator Tom Cotton (R-Ark) said of the border adjustment tax plan, “some ideas are so stupid only an intellectual could believe them.”
Congressional Republicans are getting serious flak about the plan from major U.S. industries such as retailers, auto companies, and oil companies that depend heavily on imported products and components. Heavy-weights such as Wal-Mart and Koch Industries are strongly opposed to the plan and are aggressively lobbying Congress.
The border adjustment tax plan at this point seems to have little chance of making it through Congress, even if Mr. Trump endorses the plan. The plan does have attractive-sounding goals such as encouraging production of goods in the U.S. and eliminating the incentive for U.S. corporations to shift production to lower-tax countries, not to mention raising $1.1 trillion in tax revenue to help pay for a corporate tax rate cut.
However, the plan has some serious deficiencies that we believe will be more than sufficient to sink it fairly quickly. First, the House Republicans’ current border adjustment tax plan seems to violate WTO rules, as those rules are currently written, because border adjustments can be made only on taxes, not on income. The EU is already gearing up for a major WTO legal battle against the U.S. in the event that the plan is adopted. Other countries are also likely to engage in trade retaliation against the U.S. if the plan is adopted, thus reducing the plan’s effectiveness.
Second, the whole success of the plan turns on whether the dollar appreciates by some 20% to offset the effects of the new 20% import tax. If not, then the price of imported goods (including oil) will rise sharply for U.S. consumers and many narrow-margin import companies will go bankrupt. Promoters of the plan say that the dollar will adjust upward due to trade shifts, but the more convincing counter-argument is that the dollar will not adjust by nearly enough because financial flows swamp trade flows as to the factors that ultimately cause the value of dollar to shift.
Third, if the dollar does appreciate by 20% and neutralizes the import tax, then a massive amount of U.S. wealth held overseas will be destroyed by that appreciation of the dollar. In addressing the question of who will pay for the tax in the end if the plan works out the way in which it is designed, the Tax Foundation says it will be U.S. holders of overseas assets. A group of Harvard and Princeton economics professors estimate that $2.4 trillion (13% of GDP) of U.S. wealth held overseas would be destroyed by the plan. Other collateral damage from a 20% appreciation in the dollar could be a crisis in developing countries that would be forced to repay dollar-denominated debt that becomes 20% more expensive.
Border adjustment tax plan not likely to survive — The markets are hoping for some clarity on the tax-cut situation when President Trump in 1-1/2 weeks on Feb 28 delivers his address to a joint session of Congress. That speech is not being billed as an official State of the Union address since that name is reserved for a year into a president’s term. But regardless of its name, the speech will be a high-profile event at which Mr. President Trump could announce his tax agenda.
President Trump last Thursday said that he would announce “something phenomenal in terms of tax” over “the next two or three weeks.” The markets suspect that Mr. Trump was referring to his Feb 28 speech to Congress for an announcement since the timing lines up. In any case, the stock market last Thursday took off and never looked back from Mr. Trump’s mere mention of a “phenomenal” tax plan.
By all accounts, Gary Cohn, current National Economic Council director and former Goldman Sachs president and COO, is leading the Trump administration’s effort to develop a tax plan. He has been consulting closely with House Republicans.
The Trump tax plan will likely include key elements of the House Republicans’ plan, which involves a cut in the corporate tax rate to 20% from 35%, a low 8.75% tax on the deemed repatriation of the $2.6 trillion in U.S. corporate profits that are parked overseas, a border adjustment tax plan with a 20% tax on imports, dropping the deductibility of interest, and allowing the immediate expensing of capital investments, among other items.
There is little doubt that the final legislation that gets through Congress will include a cut in the corporate tax rate and a low one-time tax on repatriated profits that will help bring in some offsetting revenue. However, the big question is whether the final Trump/Republican plan will include the border adjustment tax system. Without the estimated $1.1 trillion in revenue over ten years from the border adjustment tax system, Republicans will not be able to cut the corporate tax to as low as 20% from the current 35%. In fact, the Tax Foundation estimates that the corporate tax could be cut to only 27% without the border adjustment revenue.
Republicans plan to push the corporate tax plan through Congress using the reconciliation process, which eliminates the ability of Senate Democrats to filibuster. However, getting the border adjustment tax system through the Senate will not be easy since Republican leaders can afford to lose only three Republican Senators due to their narrow 52-48 majority (VP Pence can break a 50-50 tie).
Two of the three Republican Senators needed to oppose the plan have already become known. Senator David Perdue (R-GA) last week sent a letter to his fellow Senators urging them to reject the border adjustment tax, saying, “This 20% tax on all imports is regressive, hammers consumers, and shuts down economic growth.” Senator Tom Cotton (R-Ark) said of the border adjustment tax plan, “some ideas are so stupid only an intellectual could believe them.”
Congressional Republicans are getting serious flak about the plan from major U.S. industries such as retailers, auto companies, and oil companies that depend heavily on imported products and components. Heavy-weights such as Wal-Mart and Koch Industries are strongly opposed to the plan and are aggressively lobbying Congress.
The border adjustment tax plan at this point seems to have little chance of making it through Congress, even if Mr. Trump endorses the plan. The plan does have attractive-sounding goals such as encouraging production of goods in the U.S. and eliminating the incentive for U.S. corporations to shift production to lower-tax countries, not to mention raising $1.1 trillion in tax revenue to help pay for a corporate tax rate cut.
However, the plan has some serious deficiencies that we believe will be more than sufficient to sink it fairly quickly. First, the House Republicans’ current border adjustment tax plan seems to violate WTO rules, as those rules are currently written, because border adjustments can be made only on taxes, not on income. The EU is already gearing up for a major WTO legal battle against the U.S. in the event that the plan is adopted. Other countries are also likely to engage in trade retaliation against the U.S. if the plan is adopted, thus reducing the plan’s effectiveness.
Second, the whole success of the plan turns on whether the dollar appreciates by some 20% to offset the effects of the new 20% import tax. If not, then the price of imported goods (including oil) will rise sharply for U.S. consumers and many narrow-margin import companies will go bankrupt. Promoters of the plan say that the dollar will adjust upward due to trade shifts, but the more convincing counter-argument is that the dollar will not adjust by nearly enough because financial flows swamp trade flows as to the factors that ultimately cause the value of dollar to shift.
Third, if the dollar does appreciate by 20% and neutralizes the import tax, then a massive amount of U.S. wealth held overseas will be destroyed by that appreciation of the dollar. In addressing the question of who will pay for the tax in the end if the plan works out the way in which it is designed, the Tax Foundation says it will be U.S. holders of overseas assets. A group of Harvard and Princeton economics professors estimate that $2.4 trillion (13% of GDP) of U.S. wealth held overseas would be destroyed by the plan. Other collateral damage from a 20% appreciation in the dollar could be a crisis in developing countries that would be forced to repay dollar-denominated debt that becomes 20% more expensive.