Border Adjustability

| 1/12/2017


The 115th Congress gaveled into session on Jan. 3, 2017, and while it is still working through the procedures to organize itself, set leadership positions, and fill the rosters of the various committees, behind-the-scenes discussions continue on the top priorities for the unified Republican government. Among those top priorities is comprehensive tax reform.

A formal legislative strategy has not yet been announced, but several elected officials have commented that this effort could happen in two or three different legislative packages (healthcare taxes, corporate and international taxes, and personal taxes). The House Ways and Means Committee’s blueprint for tax reform was released in June 2016 and includes an approach that is gaining attention as a potential stumbling block. In keeping with the intention to move to a territorial-based system, the blueprint includes a destination-based (border adjustability) international tax model that would incentivize businesses to redomesticate their supply chains and would impose a significant tax increase on importers.

If enacted, border adjustability could work as follows: Assume a U.S. manufacturer produces goods for a cost of $500 and the goods are sold to a foreign purchaser for $700. The U.S. manufacturer would exclude the $700 foreign sale from its gross receipts and would not be entitled to a $500 cost-of-goods-sold deduction. The $200 profit would not be subject to U.S. taxation. On the other hand, assume a U.S. corporation buys goods from a foreign corporation (including goods produced by foreign subsidiaries) for $500 and sells the goods to a U.S. customer for $700. The $700 would be included in the U.S. corporation’s gross receipts, and the corporation would not get a cost-of-goods-sold deduction for the $500 paid to the foreign manufacturer. The blueprint also proposes that border adjustability apply to services. President-elect Donald Trump’s proposals do not include border adjustability, but he has broadly proposed tariffs on imported goods without providing any specific details.

The border adjustability provision is drawing skepticism from multinational manufacturers with global supply chains and retailers who believe they will be at a competitive disadvantage selling in the U.S. market.

This provision is important to the legislative process because many third-party economists believe it will raise revenue by $1.1 trillion over a decade. This influx of revenue would be used to offset the lost revenue from a significant reduction in the corporate tax rates. Without the added revenue from the border adjustability provisions, Congress may not be able to lower tax rates without substantially adding to the national debt.

No official tax reform legislation has been drafted, but the reaction of industry leaders to the border-adjustable regime will indicate if this is a path on which congressional leaders can continue.

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