My take on the Republicans’ new, interesting corporate tax plan

A lot of folks – OK, four people, but that’s a lot for this sort of thing – have asked me what I think of this new tax idea Republicans are pushing to replace the current corporate tax: a destination based, border-adjusted tax on cash flow. (Let’s call it a BAT – border-adjustment tax – as does the CNNMoney team in this useful explainer; it even has a hashtag: #DBCFT.) Sounds tricky, but the basics are straightforward, and have more appeal than you might think. But there are also legitimate concerns, not the least of which is that the BAT is one potentially good part of a really damaging tax package.

First, a brief description. The BAT makes a number of consequential changes to the current corporate tax:

– Destination basis: Instead of taxing corporate income minus costs (i.e., profits), the BAT taxes U.S. sales at their destination. This is a simple, smart change for one very good reason: It takes tax-avoidance location decisions off the table. Right now, because they don’t have to pay taxes on foreign profits held (or booked) abroad, a U.S. firm that sells stuff here has a huge incentive to locate in some tax haven. Under the BAT, however, any goods or service sold here is taxed here, regardless of where it is produced.

– Border adjustment: That means U.S. exports, as they’re sold abroad, are no longer taxed; conversely, domestic firms can no longer net out the cost of imported inputs from their taxable income. This, too, sounds like an attractive feature: a tax on the trade deficit! But there’s a wrinkle I’ll get to in a sec.

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– Lower rate: The Republican proposal calls for a 20 percent corporate tax rate, down from the current statutory rate of 35 percent (though given all the loopholes and carve-outs in the current system, the effective corporate rate – firms’ actual liability as a share of their income – is closer to 25 percent).

– 100 percent expensing: Capital investments would be fully expensed upon purchase (no depreciation schedules), and interest expenses would no longer be deductible.

As the nonpartisan Tax Policy Center notes: “Adopting a destination-based tax system and eliminating deductibility of net interest expense would eliminate U.S. corporations’ incentives to move their tax residences overseas (i.e., ‘corporate inversions’) and to recharacterize domestic corporate income as foreign-source income. Border adjustability would remove these incentives, because the amount of U.S. income tax a corporation paid would not depend on where it was incorporated, where its product or service was produced, or where its shareholders resided.”

TPC also estimates that the BAT raises over $1 trillion over a decade. To be sure, and this is important, the Republican plan still manages to lose around $3 trillion, on net, so this revenue-raising part is probably important to them.

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OK, them’s the technical details. What do I think of this change?

I apologize to readers who want a clean thumbs up or down. The fact is, it’s a big change, and no one knows how it will play out. That’s not a reason to oppose it – the current corporate code is a hot mess, fraught with loopholes and special treatment to chosen players. But there’s much we don’t know about how this significant change would play out in the real world.

One key bit of information that’s sorely lacking is a handy distributional table showing how the tax affects different income groups relative to the current system. By taxing imports, for example, it could raise consumer prices on cheap stuff at Walmart, gas at the pump and other goods with imported components. Since the poor spend more (and save less) of their incomes, that’s a potential regressive aspect of the destination tax.

But here’s where that wrinkle comes in. Advocates of the tax claim that it will neither affect consumer prices nor the trade balance because the exchange rate – the value of the dollar relative to the currencies of our trading partners – will fully adjust to offset the BAT. That is, because the tax system will now subsidize net exports, the volume of exports will rise and that of imports will shrink.

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Granted that sounds like a lower trade deficit, but that deficit is measured in dollars, not volumes. And these relative flows will boost the value of the dollar, making exports more expensive and imports cheaper. Importers that lose a 20 percent deduction (as they can no longer deduct the cost of imports) will make it up by an exchange-rate induced price cut (the Tax Foundation has a useful explainer on this point). Assuming they pass these price savings onto consumers, all clear on that front too.

Except nobody knows if it will work. I’d give long odds that the dollar appreciates, but how much is anyone’s guess. First, like I said, this is a big, new change, so any estimates of adjustments to it must be ingested with extra salt. Second, the adjustment theory assumes freely floating exchange rates, but we know countries manage their exchange rates. Third, what little evidence I’ve seen for roughly similar cases suggests much smaller dollar adjustments than the ones needed here.

This last point is germane. The algebra for full offset requires the dollar to rise by t/ (1-t) where t is the tax rate. The proposed 20 percent rate requires a 25 percent appreciation. But just for fun, let’s pretend there are some Republicans who actually give a crap about our long-term fiscal health. That calls for a higher tax rate, which, once you plug it into the formula, calls for an even greater dollar appreciation.

Because of this uncertainty, big retailers like Walmart and Target, firms whose business model depends on cheap imports, are fighting hard against the BAT, and let me assure you that their lobbyists are neither amused nor entertained by elegant theories of full dollar adjustment. My strong suspicion is that they’ll kill this tax.

If so, wiping out a big payfor will severely crimp the full plan, so I’m not sure what happens next. I like many aspects of this idea, especially the sales-based destination part and the elimination of interest deductibility (unless you’re running a private equity firm, you should agree with me that heavily subsidizing leverage is a really bad idea). Also, if the dollar doesn’t fully adjust, the plan is likely to lower the trade deficit, though part of that would be reflected in higher consumer prices, which probably catches the Fed’s attention, and so on into all sorts of unknowns.

But the main problem with the BAT is that it’s part of a big, highly regressive tax plan that ultimately delivers virtually all of its benefits to the top 1 percent while stiffing the Treasury, on net, of much needed revenue. As I’ve written in many places, both this plan and President-elect Donald Trump’s plan are nothing more than the latest entries in the failed trickle-down tax cut experiment. Their ultimate goals to further enrich the wealthy, shrink government and force large deficits could well put social insurance programs on the chopping block.

If so, the BAT, for all its potentially useful attributes, is a swing and a miss.

Bernstein, a former chief economist to Vice President Joe Biden, is a senior fellow at the Center on Budget and Policy Priorities and author of the new book ‘The Reconnection Agenda: Reuniting Growth and Prosperity.’