Comprehensive tax reform is hard enough for Congress, since every issue has vested interests that might gain or lose. But it’s become even more complicated this go round, because tax reformers in the House have included an idea that seemed new and unfamiliar to many: a border-adjusted tax.
In truth, the border-adjusted tax is not a new idea at all – in fact, in 2002, IPI published a paper that described the merits and the functions of a border adjusted tax. Border adjustment is the logical extension of moving the U.S. tax code from a global tax on production to a system where consumption is taxed at its destination. So if U.S. produced goods are consumed in the U.S., they are subject to the U.S. tax code, but if they are consumed globally, they are exempted from U.S. taxation. Similarly, if foreign produced goods are consumed in the U.S., they must be taxed in the U.S., which requires border adjustment.
The border adjusted tax is thus a major shift in thinking for the U.S. corporate tax system—two shifts, in fact. It’s a shift from a tax on production to a tax on consumption, and a shift from global taxation to domestic taxation. These are principles that many tax reformers have championed for years.
The border-adjusted tax has a similar effect, though a different structure, from the tax systems of most of our competitor nations. And it also has the effect of importing a tax base, which means it raises federal revenue without taxing U.S. producers.
It’s this final effect that has drawn the most attention, because proponents have been selling border-adjustment as a “pay-for” that allows for both rate reductions and revenue neutrality. And pay-fors are necessary if tax reform has to take place within the box of revenue neutrality.
We’ve never believed tax cuts or tax reform must be revenue neutral. In fact, because revenue-neutral tax reform isn’t actually an overall tax cut, we’re skeptical it would significantly stimulate economic growth.
But the worst thing about revenue neutrality is that it leads to bad tax policy. We shouldn’t introduce bad ideas like eliminating the deductibility of business interest just because they function as pay-fors in a revenue-neutral reform.
We’re agnostic on the border adjusted tax—this is, literally, a political choice that must be made. But honest proponents should be selling it on its own merit, not as a pay-for. They shouldn’t resort to questionable assertions that currency adjustments will mitigate any negative impacts, and should acknowledge its biases and disruptions, including the likelihood of somewhat higher prices for imported goods. They should offer to phase-in the border adjustment’s more onerous impacts, and perhaps limit it to finished goods.
And if the border adjusted tax doesn’t pass final political muster, it’s fine to go with tax cuts that are not revenue neutral.