U.S. Tax Reform Faces an Unsettled Future Involving Taxes at the Border

Tax reform proposals put forth by both President Trump and Republicans in Congress have been generally well received, particularly those components calling for a material reduction in tax rates. A good share of the credit for the recent advances in the stock markets can be assigned to the expectation of such initiatives being enacted.

As noted in a prior blog post touching upon tax reform, the path to enactment will involve some level of friction and a need to work out compromises involving the differences between the President’s and the GOP’s proposed reform measures.

One area of growing concern involves differences between Trump’s proposed tariff on imports and the House GOP’s border adjustment tax proposal.

A border adjustment tax lies at the core of the House GOP’s tax reform “Blueprint” released last summer. If enacted, it would lead to a tax environment dependent upon where a good is consumed, rather than where it is produced. For example, if a company makes auto parts in the U.S. which it then exports to Mexico, where those parts are then used to assemble cars, the profit on the exported auto parts would not be subject to U.S. tax. However, if the company were to import foreign-manufactured auto parts into the U.S. which it then uses to assemble cars that are sold in the U.S., the profit on the sale of those cars would be subject to U.S. tax, with the cost of the imported auto parts not allowed as a deduction in computing such profit.

A border adjustment tax would arguably reduce incentives for companies to move profit-generating activities outside of the U.S. However, opponents argue that it would lead to higher prices for U.S. consumers on imported goods.

President Trump has made reference to a tariffs-based system which would impose a 35 percent tax on U.S. companies that move jobs out of the U.S. and, in turn, import products back into the U.S. Details as to how such a tax regime would be carried out have not yet been provided.

Initial reactions to the concept of a border adjustment tax from President Trump were not generally favorable. More recently, however, he has been more positive, suggesting that a border adjustment tax could boost exports and lead to more U.S. jobs.

Executives at a number of major U.S. companies have expressed alarm at such a tax system, leading to a number of Senate Republicans now suggesting that tax reform built with a border adjustment tax as a core component could be unlikely to be enacted.

Resolution of this issue could prove to be a critical element in both the timing and the ultimate passage of major tax reform in 2017. Stay tuned!