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An agent of the border patrol, observes near the Mexico-US border fence, on the Mexican side, separating the towns of Anapra, Mexico and Sunland Park, New Mexico, Wednesday, Jan. 25, 2017. U.S.  Photograph by Christian Torres—AP

It’s Americans, Not Mexicans, Who Will Pay the Border Tax

Feb 27, 2017

To hear its champions praise it, the border adjustment tax (BAT) is that one, miraculous levy that nobody really pays for. House Speaker Paul Ryan is promoting the BAT as the ticket to slashing corporate and personal taxes. Conservative think tanks love it. And even White House spokesman Sean Spicer has touted a tariff on Mexican imports, something that sounds a lot like the BAT, that would pay for President Trump's signature wall barricading our southern border.

The BAT would penalize imports by imposing the U.S. corporate income tax not just on profits, but on all revenues collected by companies selling their foreign-made goods stateside. That penalty would raise their costs around 20%. It would reward exporters by substituting today's taxes on profits with a rich rebate. Hence, you'd think that the BAT would raise prices on imported clothes and cars to U.S. consumers.

But its supporters–including noted economists–swear that the tax would cause the dollar to appreciate over 20% against foreign currencies, precisely offsetting the new levy, effectively keeping both the import prices, and the volumes sold, unchanged. The robust dollar wouldn't hurt exports either, since the rich subsidies to American goods makers would lower costs the same amount as the rise in the greenback. Best of all, the BAT would raise as much as $1.2 trillion over the next decade, helping pay for a steep, historic reduction in corporate rates that would greatly enhance the competitiveness of U.S. companies on the global stage.

It all sounds great. The cheap jeans and appliances from China and Mexico stay just as cheap, U.S. exporters don't miss a beat, and the Treasury raises tons of money, paying for long-overdue tax reform without touching programs prized by Congress. Let's assume for the moment that U.S. retailers' fears of higher costs are misplaced because, as theory dictates, the cost of their imported products are destined to remain flat. So what's not to like?

Don't be fooled. The tonic of lower corporate taxes may outweigh the BAT's drawbacks, but it still imposes a stiff burden on America's investors and consumers. "You don't get something for nothing," says Alan Auerbach, economics professor at Berkeley.

After all, the BAT is a tax, and a big one. But it isn't paid through payroll deductions, or added to your tab at McDonald's or Target. Its penalties are indirect, but real. Here's how the would BAT hit Americans' wealth and incomes. The U.S. has been running huge trade deficits for decades. The extra dollars that Mexico or China amass by selling a lot more to us than we sell to them get invested in Treasuries, U.S. equities, corporate acquisitions and new plants. If the BAT forces a 25% rise in the dollar, the interest and profits from those investments will be worth that much more in pesos and yuan. Hence, citizens of our creditor nations will get richer relative to our own citizens. "Foreign investors will get a major windfall from the BAT," says Alan Viard of the American Enterprise Institute.

That simply means they're doing better than before, not necessarily that we're doing worse. But all other things remaining equal, we will be doing worse. U.S. companies and individuals, generally via investment funds, own trillions of dollars' worth of investments in other countries. These range from U.S. companies' ownership of vast manufacturing and research facilities abroad, investors' holdings in overseas companies that book their earnings in yen or euros, and real estate funds' portfolios of office buildings in Paris or Tokyo.

The projected rise in the dollar will reduce the value of dividends, interest and rent from all those investments, once translated into dollars, by double-digits. Since their future income (measured in dollars) will fall sharply, so will their market value in greenbacks, making Americans a lot less wealthy. It's likely that the hit to foreign income and wealth will equal the $120 billion a year the U.S. would collect from the BAT. That penalty is the equivalent of a reduction in GDP of around 0.5%.

Not to say the BAT isn't a good idea. Lowering corporate taxes to 15% or 20%, from their current 35%, would be an overwhelming positive that could swamp the drag from lower foreign income. So all other things could get a lot better. Thankfully, the BAT is likely to be coupled with substantially lower rates, since it's the engine for paying for those reductions. But if somehow the BAT is enacted, and tax reform is weakened, America may be worse off. The BAT may be the cost of tax reform, but make no mistake--it's a cost, and a big one.

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