Border Adjustment Tax (BAT)

What Is Border Adjustment Tax?

Border adjustment tax is a short name for a proposed destination-based cash flow tax (DBCFT). It is a value-added tax on imported goods and is also referred to as a border-adjusted tax, destination tax or border tax adjustment. In this scenario, exported goods are exempt from tax while imported goods sold in the United States are subject to the tax.

Understanding Border Adjustment Tax

The border adjustment tax (BAT) levies a tax depending on where a good is consumed rather than where it is produced. For example, if a corporation ships tires to Mexico where they will be used to make cars, the profit the tire company makes on the tires it exports is not taxed. However, if a U.S. car company purchases tires from Mexico for use in cars made in the United States, the money the company makes on the cars (including the tires) sold in the United States is taxed. In addition, the company cannot deduct the cost of the imported tires as a business expense. The concept was first introduced by 1997 by economist Alan J. Auerbach, who believed that the tax system would be in line with business goals and the national interest.

The Theory Behind the BAT

A tax on consumer goods typically increases consumer prices, but Auerbach's theory contends that the BAT would strengthen the domestic currency and that the stronger domestic currency would effectively reduce the price of imported goods. This effectively cancels out a higher tax on imports.

This tax is designed to even out imbalances in money flows across borders and reduce corporations' incentive to off-shore profits. This makes the DBCFT a tax and not a tariff. Although it is a tax on imports and an export subsidy, the rate of border adjustments is paired and symmetric. Thus, the effects on trade of these two components – the import tax and the export subsidy – are offsetting. Applying them together imposes no-trade distortions although adopting either separately would.

Critics of the tax argue that prices will rise on imported goods, from China for example and that the result will be inflation. Proponents of the tax purport that the surge in foreign demand for U.S. exports will strengthen the value of the dollar. In turn, a strong dollar would increase the demand for imported goods, so that the net effect on trade is neutral.

If BAT were adopted, any company that sold goods in the United States, regardless of where the company bases its headquarters or production facilities would be subject to tax. If it does not sell goods in the United States, it would not be subject to the tax. If a product is manufactured in America and consumed abroad, that product would also be free of tax. Thus, the U.S. tax rate or tax burden is not a factor in the firm’s decision on where to locate.

Where the BAT Stands Now

In the United States, Auerbach's recommendations were presented by the Republican Party in 2016 in a policy paper that promoted a destination-basis tax system. In February 2017, the proposal was the subject of heated debate with Gary Cohn, director of the National Economic Council, opposing the tax system and a lobby group, Americans for Prosperity (AFP) funded by the Koch brothers, initiating a plan to fight the tax.

Proponents of the tax believe that the United States would become a desirable place for the location of businesses and investments and would stop businesses from locating abroad. This would create U.S. jobs and would mean that American workers do not have to pay for corporate tax cuts.