Tariffs or Border Adjustment taxes – Is there a Difference?
by jdledell

Donald Trump in his campaign for President made a lot of noise about unfair trade deals and its negative effects on the American economy. Many times he threatened to slap a 35% tariff on imported goods. This would be a higher tariff than even under the infamous Smoot-Hawley tariffs which were instrumental in bringing about a world-wide depression in the 1930’s. The Smoot-Hawley tariffs were about 60% but they only applied to certain goods and services. The net result was about a 20% tariffs on the sum of all imported goods. Implementation of any kind of general tariffs would result in WTO condemnation and retaliatory tariffs on American exports.

The impact of a world-wide trade war would be negative both in the U.S. as well as many counties around the world. Free trade has been a boon the national economies in most of the countries of the world bringing national income increases to many peoples of the world. Of course, some parts of each national economy will suffer and it is incumbent on the national governments to mitigate those who suffer the negative consequences. Not enough of this was done in the U.S. to prevent the backlash that elected Trump.

To illustrate the advantages of free trade, I will use the example of China. The export heavy economy of China has produced hundreds of millions of middle class consumers. These middle class consumers would not exist unless China was able to produce a huge amount of products that are bought by the rest of the world. The new Chinese consumers are now able to buy hundreds of millions of IPhones which enrich Apple headquarters employees and Apple stockholders but not factory workers in the U.S who do not make IPhones. This example can be extrapolated to many export countries around the world. Henry Ford understood this principle a 100 years ago when he decided to pay his employees well over the custom wages so they could afford to buy his product.

Donald Trump wants to overturn this principle of encouraging world wide economic growth to enable world wide consumers to afford American high value added goods in exchange for their commodity produced goods. He understands (I think) the disaster that would result in straight import tariffs. Instead he a fellow Republicans in Congress are discussing a Border Tax Adjustment which they hope will pass muster with the WTO. I seriously doubt the WTO will bless this kind of subterfuge.

Essentially, companies would be able to deduct from their U.S. Federal tax filings the cost of goods and wages produced in the U.S. and exclude any revenue from exports. To illustrate Company A is a retailer who buys its products from China (think Walmart). Lets say it has $1 billion in revenue and spends $100 million on its stores and employees and $800 million on imported goods. The resulting profit of $100 million would be taxed at 35%, producing a $65 million after tax net profit. Under a border adjustment tax it still produces a $100 million profit before taxes but now it’s tax profit is considered to be $900 million ($100 million real profit plus $800 million in non deductible imports). The FIT would now be $315 million (35% of $900 million) producing a net loss of $215 million. To keep producing a 10% after tax profit Company A now has to increase its prices about 25%.

Now Company B is an export driven company (think Boeing). It produces $1 billion in revenue like Company A but 80% of it’s sales are exported with its costs in the U.S. being $900 million producing a $100 million dollar profit before tax and $65 million after tax. For tax purposes they only have to declare $200 million in U.S. sales (the $800 million in exports is not considered revenue for tax purposes). Under the new approach Company B would declare $200 million in revenue and $900 million in expenses for a tax loss of $700 million with a tax refund of about $250 million bringing their after tax income to $350 million ( $100 million normal profit plus a tax refund of $250 million).

In a gross sense this is how a Border Tax Adjustment would work. This ignores complicating issues like currency changes. For example, exporting nations would have fewer dollars from reduced exports making purchasing imports from the U.S. also lower. It also ignores the issue of export companies being more profitable and being able to reduce their prices. However, the big advantage is Trump is able to tout his promises on trade fairness without resorting to the dangers of pure tariffs. I suspect that other countries will consider this a tariff in disguise and implement tariffs or similar schemes producing a trade war anyways.

After a long career as a Senior Executive with Prudential, jdledell took early retirement to teach piano with his wife of 48 years, Cinder. The two of them established Castle LeDell Music in their home and have 130 weekly students spread out over 7 days a week. In spite of teaching being literally a full-time job, jdledell finds the time to consume vast quantities of Internet commentary and to communicate with his children and other relatives scattered around the globe. While jdledell got polio when he was two years old and now uses a wheelchair full-time, it doesn’t keep him from leading a rich and fulfilling life in Basking Ridge, NJ.

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