As the White House and Congress gear up for tax reform, one of the most discussed (and confusing) aspects of tax reform has been the inclusion of a “border adjustment tax”. In a nutshell, the border adjustment tax proposed in the House GOP blueprint taxes goods consumed in the U.S. and exempts from tax goods produced in the U.S. but consumed elsewhere. As explained in the blueprint, “[u]nder [this] destination-based approach, tax jurisdiction follows the location of consumption rather than the location of production.” For example, a company that produces shirts in the U.S. but sells the shirts outside of the U.S. would not be subject to tax, whereas a foreign company that imports shirts to the U.S. for sale would be subject to tax on the U.S. sales. Per reports, the House GOP border adjustment tax would generate approximately $100 billion annually over a 10-year budget window.
A common question with respect to the border adjustment tax is how it differs from a tariff. As the Tax Foundation explains, “[a] border-adjusted tax falls equally on domestic and imported goods, in order to tax the amount of income people spend on consumption. A domestically produced good and an imported good will face the same tax. Goods produced in the U.S. and exported abroad are exempt from taxation, but exports are not consumed at home. However, the foreign buyer may be subject to a consumption tax levied in his home country, but that is not the concern of the U.S. taxing authority.”
Critics of the border adjustment tax contend that U.S. consumers will end up paying the tax through higher prices on imported goods. However, advocates for the tax counter that the dollar exchange rate would rise and offset the added cost for U.S. consumers. As the Brookings Institute notes, this occurs in two ways. “First, the exemption of exports would raise demand for US dollars as foreigners need more dollars to purchase more exported US goods. Similarly, the tax on imports would restrict the supply of dollars worldwide as Americans made fewer purchases from abroad. The two effects would serve to raise the value of the dollar and have offsetting effects on the quantity of dollars traded.”
In sum, the border adjustment tax is a critical component of the House GOP tax reform plan and will no doubt continue to be debated as tax reform takes center stage over the next several months.