About Me

In writing the "About Me" portion of this blog I thought about the purpose of the blog - namely, preventing the growth of Socialism & stopping the Death Of Democracy in the American Republic & returning her to the "liberty to abundance" stage of our history. One word descriptions of people's philosophies or purposes are quite often inadequate. I feel that I am "liberal" meaning that I am broad minded, independent, generous, hospitable, & magnanimous. Under these terms "liberal" is a perfectly good word that has been corrupted over the years to mean the person is a left-winger or as Mark Levin more accurately wrote in his book "Liberty & Tyranny" a "statist" - someone looking for government or state control of society. I am certainly not that & have dedicated the blog to fighting this. I believe that I find what I am when I consider whether or not I am a "conservative" & specifically when I ask what is it that I am trying to conserve? It is the libertarian principles that America was founded upon & originally followed. That is the Return To Excellence that this blog is named for & is all about.

Sunday, February 26, 2017

Border Adjustability - Its Problems With An Income Tax System & Its Benefits With The FairTax

In addition to lowering the corporate income tax rate to 20% from 35% House Republicans have made border adjustability of the corporate income tax an essential part of any tax reform plan they are considering or will consider.  This position was reinforced by Kevin Brady, Chairman of the House Means & Ways Committee, @ the Conservative Political Action Conference (CPAC) on Friday.
 
Border adjustability is an important feature of the FairTax, a national consumption tax that will replace the income tax system – but border adjustability is being misused the way House Republicans are applying it to America's income tax system.
 
Simply put, border adjustable means exports are not taxed by the home country & imports are taxed whether in a country's income tax system or consumption tax system.
 
In the House Republican border-adjustable tax reform plan imports are taxed in that they would no longer be tax deductible as a regular business expense & exports are exempt from taxable income. 
 
Since the corporate income tax rate is a tax inclusive rate the proposed 20% corporate income tax rate will effectively act as a 25% tariff (tax exclusive rate) on imports & this has companies like Wal-Mart, Target, Home Depot, Lowe's, & gasoline refiners very opposed to border adjustability under the current income tax system.  Big exporters like Boeing & GE are sure to benefit from border adjustability.
 
In essence, the House Republican border-adjustable tax reform plan acts as a tax on the trade deficit –
the amount by which the cost of a country's imports exceeds the value of its exports.  S
ee graph below.
 
click on graph to enlarge
 
Effectively, the House Republican border-adjustable tax reform plan will impose a 25% tax-exclusive increase on consumers of imported products & services.  Someone currently paying $4.00 for an imported item will pay $5.00 after the cost of the import is no longer tax deductible meaning the proposed 20% corporate tax rate (20% of $5.00 = $1.00) will have the same effect as a 25% tariff (25% of $4.00 = $1.00).
 
Under the House Republican border-adjustable tax reform plan it is quite possible for tax liabilities of retailers & importers to be greater than profits – i.e., the tax liability of retailers & importers, due to losing the tax deductibility of the cost of imports, could result in higher prices, layoffs, bankruptcy, or the company going out of business.
 
Now House Republican leaders have their theories that they think will offset the cost increases on imported items & problems detailed above. 
 
First, House Republicans are counting on the lower cost of exports due to the removal of the corporate income tax on exports increasing the growth of export sales (i.e., if we sell X number of exported widgets now we will sell more when the price is lowered).  This in turn will increase the value of the dollar as more countries buy dollars to purchase the cheaper exports which will lead to lower prices of imported items, balancing out or neutralizing the effective 25% tariff, when this stronger dollar buys currencies from all the countries we purchase imports from.  But this is circular reasoning – as, or more likely if, the dollar starts to get stronger because of countries buying more cheaper exports it will not take long before the stronger dollar works against the price of the cheaper exports & accordingly the price equalizing benefit of currency changes never fully materializes for the more expensive imports.
 
In addition, Phil Gramm, visiting scholar @ the American Enterprise Institute (AEI), reports that "the value of U.S. exports plus imports makes up only 0.3% of total dollars traded."  HSBC Holdings PLC reports that "trade makes up only 1.4% of the daily trading in the U.S. dollar" so it will take another influence to make the value of the dollar rise by 25% which is what the House Republicans are counting on.  It should be noted that some countries have seen currency increases of 25% when they introduced border-adjusted value-added-taxes (VATs) – but these countries were not countries whose currencies were the world's highly traded reserve currency.
 
Another major concern for some retirees that a 25% rise in the dollar brings is the devastation to pension fund investments denominated in foreign currencies when shares are sold & the proceeds are returned to dollars.
 
In summary, it is dicey to count on currency markets to make the House Republican border-adjustable tax reform plan a success.
 
Second, House Republicans believe the border-adjustable tax reform plan will motivate companies to manufacture their products in America where the companies not only would escape the proposed tax on imports, realize the zero tax rate on exports, but would also benefit from the reduction in the corporate income tax rate from 35% to 20% on profits from domestically produced products, allow the repatriation of overseas profits, & write off capital expenses immediately instead of depreciating capital expenses over decades.  The hope is that enough companies will bring their manufacturing facilities back to America thereby creating jobs in the homeland.
 
But a major complication to the House Republican border-adjustable tax reform plan is violations to the global rules of trade (international trade agreements) between nations under the World Trade Organization (WTO).  Under the House Republican border-adjustable tax reform plan the U.S. will become the only country in the world to use the corporate income tax in a way that other countries use VATs or sales taxes to border adjust – leaving their own income tax systems out of the trade equation.  No other country disallows the tax deductibility of imports or exempts exports from corporate income tax which really are protectionist measures that would open the U.S. to challenges from other WTO members & possibly trade wars starting with other countries imposing their own punitive taxes on U.S. exports.
 
Now creating jobs, especially good paying manufacturing jobs, is what Trump is all about. 
 
Trump's focus is really on the merchandize trade balance, specifically & immediately with Mexico, not the trade deficit as the media shorthands it.  The U.S. merchandize trade deficit with Mexico was $58 billion in 2015.  There was a U.S. services trade surplus with Mexico of $9 billion in 2015 so the goods & services trade deficit with Mexico was 49 billion in 2015.  Since the services balance was positive Trump concentrates on the merchandize balance – i.e., the manufacturing sector.  Source of statistics – Office Of The United States Trade Representative.
 
Although Trump has not signed on to the House Republicans border-adjustable tax reform plan he has not ruled it out either – he once called it "too complicated."
 
The problem is not border adjustability but rather trying to put border adjustability into practice in an income tax system for the reasons described above. 
 
Please contrast the House Republicans border-adjustable tax reform plan with the following points relating border adjustability to the FairTax.
 
1.  The FairTax removes all hidden embedded taxes from American made products – not just the corporate income tax.  The FairTax eliminates the corporate income tax & the employers' share of the Social Security & Medicare payroll taxes as well as the tens of billions of dollars companies spend complying with the income tax regulations – not only on exports but on domestic consumption as well.  Accordingly, stripping all these tax costs from American products means exported products will leave America with a lower price under the FairTax than under the House Republican border-adjustable tax reform plan.
 
2.  Under the FairTax the free market will determine where manufacturing facilities are built & jobs are created – let every country determine how many tax components they want in their products when competing with American products which will have no tax components under the FairTax   The House Republican border-adjustable tax reform plan deliberately picks winners & losers – just like any income tax plan does.  One side of the FairTax equation is that all American made products & services are produced free of federal taxes on individual & business incomes, as well as payroll, estate, & capital gains taxes – the other side of the FairTax equation is that workers receive their paychecks & retirees receive their pensions free of federal taxes – i.e., no federal deductions any more.  These two sides of the FairTax equation provides a much more conducive atmosphere for prosperity, & hence economic & manufacturing activity, than having House Republicans decide which export companies will benefit & which importers & consumers will be hurt by their manipulative border-adjustable tax reform plan.
 
3.  Having no tax components in our goods & services will also act as a magnet attracting the thirty trillion dollars parked outside the U.S. that will have the incentive & propensity to be drawn to the U.S. for the exact opposite reason that it does not now - the disobliging incentives caused by the U.S. income tax system, which will be eliminated under the FairTax.  (The $30 trillion consists of money held in off shore financial centers [OFCs] & cross border financial centers comprised of many currencies whose estimated value in 2009 was $30 trillion.  The incentive the FairTax provides in this regard will be a real stimulus to our economy in that the money supply & interest rates will be affected by market forces that will work to let our economy naturally grow.  In effect the U.S. would  become the world's tax haven in that it would have no investment tax component @ all & would provide a much better  investment opportunity than places like the Cayman Islands & other OFCs.)

 

4.  As described above many retailers & importers will have to be concerned under the House Republican border-adjustable tax reform plan whether or not their tax liabilities are greater than profits after they lose the tax deductibility of the cost of their imports.  Of course this absurd state of affairs is non-existent under the FairTax & so is the income tax laws & the IRS which is abolished by the FairTax.  After enactment of the FairTax imports will be taxed @ the FairTax rate providing a level playing field for all goods & services sold in America – American made products with the current hidden embedded tax costs removed will compete against imports with their VATs removed before the FairTax is applied to both.
 

It is important to point out that the treatment of foreign products described above is not in violation of any WTO regulations that could result in fines being charged for creating a bias in our favor - like imposing tariffs or manipulating our currency.  All products, whether foreign or domestic, receive the same tax treatment after enactment of the FairTax in that the FairTax is applied to whatever price the producer of any good or service brings their products to market.  The only retaliation I see possible is if other countries also enact the FairTax.  The FairTax puts U.S. producers on the most level playing field possible - certainly @ least since embedded taxes were included in the income tax system.

 

The combination of the above points shows the positive impact the FairTax will have on the American economy.  In summary, elimination of the current embedded taxes on American goods & services will 1) put American products in a more favorable light compared to foreign imports competing for consumer sales in America, 2) contribute to increases in sales of our products traveling overseas, 3) make America the tax haven of the world thereby increasing capital brought to our shores & 4) allow the free market to determine that America is the best place for manufacturing facilities to be built & jobs to be created. 
 
All of the above features will create a robust economy unseen in America in decades that make you wonder why the FairTax was not passed into law the first five minutes after it was introduced. 
 
But you know the answer to that – don't you? 
 
Reference posts: 
 
 
 

2 comments:

  1. If the proposal described here becomes law, WTO ("World Trade Organization")-sanctioned retaliation likely will become a serious problem. The proposal contravenes Articles II and III of the General Agreement on Tariffs and Trade ("GATT") and the Agreement on Subsidies and Countervailing Measures ("SCM Agreement") as an impermissible export subsidy. GATT and the SCM Agreement permit border-adjustability of so-called "indirect taxes" such as VAT's and sales taxes, i.e., taxes paid by the goods themselves, as long as such taxes are imposed equally on foreign and domestically-produced goods. The FAIRtax(SM) meets these conditions. But the GATT and the SCM Agreement would clearly view the Republican tax proposal askance. Congress may learn this truth the hard way and then turn to the FAIRtax.

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