Episode 751: The Thing About That Border Tax

Feb 1, 2017

America's corporate tax is a mess. Republicans have a plan to fix it. But it will be a tough sell.

The new plan would lower the corporate tax rate, currently one of the highest in the world. And it would change how the tax works on a fundamental level. It's called a border adjustment tax, and it would be a huge tax break to American exporters.

Of course every tax change has winners and losers. The losers under the new tax plan would be any business that imports products. Businesses like Walmart and Target would likely pay more in taxes.

Trade economists have talked about the border adjustment tax for decades, but it is only now getting its moment in the spotlight. The Republicans in Congress are pushing it as a way to lower the corporate tax rate from 35 percent to 20 percent.

The plan even got the approval of President Donald Trump as a way to make Mexico pay for a border wall.

But on today's episode we talk to an early backer of the border adjustment tax, and he says it doesn't do what everyone thinks it does. It definitely doesn't punish Mexico or make them pay for anything. And in the end it won't even hurt the nation's importers.

The reason is complicated. We'll use a jar of marbles and a lovely music box to make sense of the Republican border adjustment tax plan.

Music: "Baiser Fatal." Find us: Twitter/ Facebook.

Copyright 2017 NPR. To see more, visit http://www.npr.org/.

ROBERT SMITH, HOST:

Jacob, as you know, there is nothing I love more than sort of just digging into a nerdy tax reform plan.

JACOB GOLDSTEIN, HOST:

Sure. Who doesn't?

SMITH: And the other day, I found one that, perhaps, is too complicated - too nerdy even for PLANET MONEY.

GOLDSTEIN: No such thing.

SMITH: Well, hear me out here. This plan is a plan to reform the corporate tax. This is the tax that corporations pay on their profits - you with me?

GOLDSTEIN: Love it.

SMITH: It's being pushed by University of California professor, Alan Auerbach. And it's called - you're going to love this - the DBCFT.

(SOUNDBITE OF AIR HORNS)

SMITH: Whoo, DBCFT.

ALAN AUERBACH: Yes, the acronym we use is a destination-based cash flow tax. But we just all call it...

SMITH: That sounds terrible.

(LAUGHTER)

SMITH: That's terrible.

AUERBACH: Yeah, we need we need some PR help. I realize that.

GOLDSTEIN: Yeah, first of all, DBCFT is obviously at least two letters too long for an acronym. Simple rule - three letters max for an acronym.

SMITH: Well, the cool kids - us among them - call it the border adjustment tax.

GOLDSTEIN: A little bit better.

SMITH: (Laughter) And we would not even be talking about this plan today, except the professor got the PR help that he needed. Last week, President Donald Trump, out of nowhere, embraced this strange, complicated tax plan, although he didn't use any of the initials. He made it sound way more dramatic.

(SOUNDBITE OF ARCHIVED RECORDING)

PRESIDENT DONALD TRUMP: Well, we're working on a tax reform bill that will reduce our trade deficits, increase American exports and will generate revenue from Mexico that will pay for the wall, if we decide to go that route.

SMITH: It's fair to say that people freaked out, at least for about two minutes. They were like - wait, what is he talking about? Is he really going to tax imports from Mexico? Is this going to increase the price of avocados? Is this the start of the U.S.-Mexico trade war?

GOLDSTEIN: And then, people realized Trump was talking about the DBCFT, the border adjustment tax, this new idea for a corporate tax.

SMITH: This was Alan Auerbach's time to shine. He had been talking about the border adjustment tax for 15 years. And now, there it was, all over the news. One small problem - Auerbach says the border adjustment tax doesn't do all of those things that Trump promised.

AUERBACH: If his objective is to punish other countries, this may not be the way to do it. But if what he wants to do is to encourage investment, production and employment and higher wages in the United States, then I think this would fit the bill.

SMITH: This is such a strange moment in U.S. history that a protectionist president and a free-trade economist may have found some common ground, common ground that could overhaul the corporate tax system.

Hello, and welcome to PLANET MONEY. I'm Robert Smith.

GOLDSTEIN: And I'm Jacob Goldstein. We are taking today's show to just pause. You know, there's an extraordinary amount of news coming out of Washington, D.C. We're going to pause today and just explain this one wonky, really important economic thing, the corporate income tax, and how it may be about to change in a big way.

SMITH: Today on the show, a corporate tax plan so crazy it just might work, although not the way the president thinks it will.

(SOUNDBITE OF MUSIC)

SMITH: All right, let's do this thing, the border adjustment tax. The border adjustment tax is a replacement for the corporate tax.

GOLDSTEIN: The corporate tax in America is a mess, your classic bad tax.

SMITH: Because first of all, it is an incredibly high tax - 35 percent. That is the tax levied on profits of corporations. That is the highest in the developed world. And it's kind of embarrassing to be the United States of America, home of business and capitalism, and to also have the highest corporate tax rate in the developed world.

GOLDSTEIN: Yes. And on top of that, there are tons of loopholes, which is your classic bad tax combination - high statutory rate, tons of loopholes. And all of these loopholes means companies have a huge incentive to hire all these lawyers to do crazy, global tax shenanigans.

SMITH: So for instance, professor Auerbach from UC Berkeley says a global company can sell something in the United States and say - well, we didn't make a profit in the United States. We made a profit in our subsidiary in Ireland. And it would be hard to track down that money.

AUERBACH: Where does a company like Apple earn the money that it makes on an iPhone? Is it earned in Silicon Valley? Does it earn it in China? Does it earn it in Ireland, where it has some of its intellectual property? It's really hard to know.

SMITH: A lot of politicians, people who run the U.S. government, know that this is a problem. And that's why there's pretty general support for lowering the corporate tax rate. President Barack Obama thought the corporate tax rate was too high. He wanted to lower it. President Donald Trump promised on the campaign trail that he would lower the corporate tax rate. And the Republicans in Congress, they're currently proposing dropping it from 35 percent to 20 percent.

GOLDSTEIN: But if you lower the rate that much, even if you get rid of a lot of those loopholes, the government is still going to wind up with less money every year.

SMITH: Yeah. It's one of the major sources of income for the U.S. government. So where do they get the money? This - this, my friend, is where the border adjustment tax comes in.

GOLDSTEIN: DBCFT.

SMITH: DBCFT - which, when you hear it, you will have to admit is a pretty clever solution. In fact, to Republicans in Congress, this is among the tax plans that they are looking at right now. It is sort of on their short list of things to do. We will explain the border adjustment tax.

GOLDSTEIN: OK. The way the corporate tax works now - if you are an American company, you have to pay the U.S. corporate tax on your profits wherever you sell your goods. So if you make your goods here, you sell them here - you pay the corporate tax. You make them here, you sell them in China or in Europe - you also pay the U.S. corporate tax.

SMITH: Profit is profit. You've got to pay a corporate tax on profits. The border adjustment tax says to companies - listen, we don't care where you technically book your profits - Apple.

(LAUGHTER)

SMITH: We don't care where you technically book your profits. What we care about is where you sell your products. Do you sell your products in the United States of America?

AUERBACH: The philosophy of it is to say - look, we're not exactly sure what corporate residence means anymore. And we're not exactly sure where profits are being earned, but we're pretty sure we know where consumers are. And if Americans are buying things, regardless of where they're produced, if they're purchased in the U.S., we want to put a tax on them. And if they're not, we don't. And that's a very viable tax system.

GOLDSTEIN: Go ahead. Say you're making all your money in Ireland. We don't care. We just care where you're selling your stuff. If you're selling stuff to Americans in America, you're going to pay the corporate tax.

SMITH: And this is not a new, crazy idea. A lot of countries around the world have something that is sort of similar. It's called a VAT tax, perhaps you've heard of it, value added tax.

GOLDSTEIN: So - OK, Robert, border adjustment tax - let's actually work out how this would actually work for a business.

SMITH: OK. So let's say I have a company, a company that sells something - you know, for the sake of podcasting - that makes a noise.

GOLDSTEIN: OK, a jar full of marbles.

(SOUNDBITE OF MARBLES BRING SHAKEN)

SMITH: It's a jar full of marbles (laughter).

GOLDSTEIN: It's a terrible product. Don't ever do that again.

(SOUNDBITE OF MARBLES BEING SHAKEN)

SMITH: OK. That's going to get annoying. So let's just say I have a corporation that sells sweet, sweet music boxes.

(SOUNDBITE OF MUSIC BOX PLAYING TCHAIKOVSKY'S "DANCE OF THE SUGAR PLUM FAIRY")

GOLDSTEIN: So, Robert, in the current corporate tax universe, you've got your precious little music box company in Brooklyn. You pay the corporate tax on your profits, no matter where you sell your music boxes.

SMITH: Thirty-five percent is the tax I pay on the profits. This substantially changes under the border adjustment tax. Under this new tax, if it were to pass, the big changes come from my music box corporation if I decide to export a product or import a product.

GOLDSTEIN: And Robert, you talked about your music box business with Alan Auerbach, the Berkeley prof, and you guys started with exports.

SMITH: Let's just say these things become the rage in Mexico City and I start to export them. I start to sell Brooklyn-made music boxes in Mexico City.

AUERBACH: OK.

SMITH: How is that different? Yeah.

AUERBACH: Well, if you sold your music box for $500, the $500...

SMITH: Oh, that's a good one (laughter).

AUERBACH: Well, yeah - I mean, you're making them in New York. I assume they're very high end.

SMITH: (Laughter) Of course.

AUERBACH: The - assuming that you sell it for $500, the $500 would just be ignored by the IRS. It wouldn't go into your tax calculation. That would be the only change, but it's obviously a very big change from the previous circumstance.

GOLDSTEIN: So to be clear, Robert, under this proposal - under the border adjustment, if you sell your music boxes in the U.S., you still have to pay tax on your profits. Sell them in Mexico or in any other country in the world - no tax on your profits.

SMITH: This is a huge incentive for me to export music boxes. And in fact, a huge incentive for all U.S. exporters. I mean, we're just talking music boxes here. Boeing sells one plane for $300 million. Imagine that tax-free.

GOLDSTEIN: Yeah, this is a windfall for U.S. exporters.

SMITH: There is another half to this equation.

(LAUGHTER)

GOLDSTEIN: Yes.

SMITH: The tax giveth, and the tax taketh away because - let's just say I have those music boxes made in China. They are much cheaper to make there. I can make a larger profit. But my customers are in America. And this time, I do have to pay a tax.

AUERBACH: So if you import that music box for $100 - because it's cheaper to make it in China than it is in New York - and then you sell it for $500, the $500 would be taxable if it's sold in New York. So you'd be taxable on the entire thing.

SMITH: Hm.

AUERBACH: So maybe you'll rethink that decision to outsource your production.

SMITH: (Laughter) Or maybe I'll just charge people more if I'm...

AUERBACH: You might.

SMITH: ...(Unintelligible) business.

AUERBACH: You might.

SMITH: If your head is reeling trying to do the math, I'm sure most businesses in the United States will also be trying to figure this out. This is a good time to employ a tax lawyer. But I'm going to sum this up - if you are an importer in the United States of America, under the border adjustment tax, you will pay a pretty hefty tax. If you are an exporter, you will not. It's a sweet deal.

GOLDSTEIN: And, you know, this seems like it would create an incentive to make more things in the U.S., to export more stuff and a disincentive to import stuff. This is the part, not surprisingly, that President Trump is focusing on, the kind of big, macro implications. But it's also worth looking at just, like - what does it mean to me? What is it - how's it going to affect consumers?

SMITH: Well, look at all the stuff you've bought recently. Was a lot of imported? The odds are a lot of it was imported. Whether it's at Wal-Mart or Target, Crate and Barrel, Best Buy - that stuff is brought into the country by American corporations. And if those companies are charged more in taxes because they're importers - big surprise - they are probably going to raise their prices.

GOLDSTEIN: If these companies have to pay more in taxes, there's a good chance they're going to pass that on to us. We'll have to pay more for the stuff we buy.

SMITH: And importers are already lobbying Congress, saying - what are you doing? This plan, this border adjustment tax, would kill us - and not just us but your constituents - and not just your constituents but your poorest of constituents, who buy a lot of things at Wal-Mart and Target. They're the ones who are going to basically take the burden of this border adjustment tax.

We want to know what this would mean for the broader economy, so we called up Megan Green. She's the chief economist at John Hancock.

MEGAN GREENE: As importers are having to pay this tax, they're probably going to pass the price of that onto the end consumer. So that means consumers are going to have to pay more for goods. And that's bad for the consumer and also means prices will rise. So we'll have inflation and lower growth because the consumer will be facing this big tax. So we'd be paying more, but the economy won't be in as good shape. And that's negative for the U.S. economy.

GOLDSTEIN: And to be clear, not everybody thinks all these things would happen. People like professor Auerbach, the supporters of the border adjustment tax say, yes, there will be some short time of adjustment where prices might go up. But eventually, they say, things will return to normal.

SMITH: If you've made it this far in the podcast (laughter), then...

AUERBACH: Thank you, first of all.

SMITH: Thank you. And you are in for a treat because we're going to talk about one of the most mystical and satisfying things in economics. We are going to talk about currency exchange rates.

GOLDSTEIN: (Whispering breathily) Currency exchange rates.

SMITH: Currency exchange rates, the value of the dollar and how that is going to affect this whole thing. It'll be short. We'll make it easy. I promise.

GOLDSTEIN: Three steps.

SMITH: OK.

GOLDSTEIN: So step one - if we do a border adjustment, step one is imports get more expensive. And as a result, we import less. That's part of the point.

SMITH: Step two - at this point, the value of the U.S. dollar - relative to all those other foreign currencies, the value of the U.S. dollar goes up. The dollar gets stronger.

GOLDSTEIN: And step three, the stronger dollar has the effect of making imports cheaper.

So to recap - you put the tax on, imports get more expensive, then the value of the dollar changes - imports get cheaper again. You are basically back where you started.

SMITH: In theory.

GOLDSTEIN: In the textbook.

SMITH: In the textbook?

GOLDSTEIN: In the textbook, that is absolutely what happens...

SMITH: In the economics textbook?

GOLDSTEIN: ...I promise you that.

SMITH: The debate going on right now among economists across the country is - how long will it take for the economy to adjust? If you put in this border adjustment tax, how long will it take for the economy to return to normal? Days? Months? Years? No one knows. Alan Auerbach, the guy who pushed this idea, he thinks it will happen almost overnight, meaning - drumroll - or these marbles in a jar.

(SOUNDBITE OF MARBLES BEING SHAKEN)

SMITH: The border adjustment tax will, in theory, in the end, have very little effect on imports and exports.

GOLDSTEIN: Come on.

SMITH: I know. This...

GOLDSTEIN: After all that?

SMITH: ...Blew my mind.

GOLDSTEIN: Robert, you asked the obvious question to professor Auerbach.

SMITH: So (laughter) if you go to all this trouble, get people together, change the laws, change the very nature of our corporate tax system. And then, at the end, everything's the same, why do that?

AUERBACH: Not quite. I think the border adjustments themselves, in terms of their impact, are not going to have much of an impact. It's really the changes in incentives that companies have to locate production in the U.S. versus other countries, their loss of ability among those companies that are aggressively shifting their taxable profits to other countries, loss of ability to do that. I think that's where one should focus in thinking about which companies are going to be the winners and which are going to be the losers.

SMITH: So, you know, all those tax shenanigans you read about - about companies booking their profits in foreign countries, about holding money overseas - all the incentives for all of those shenanigans go away with this tax, according to Auerbach.

GOLDSTEIN: But everything else stays the same.

SMITH: No one is punished. Importers are fine. Exporters are fine. Mexico still will not be paying for the wall - if it gets built.

GOLDSTEIN: OK. I get the theory behind that. I get the textbook part of that. But I do still wonder - I mean, A, it might not happen that way. But B, what is it going to mean for our economic relationships with the rest of the world, right? I mean, if you're saying - hey, we're going to, you know, put this tax on imports and give a sweet deal to our exports, is that going to, like - I don't know - is that going to start a trade war, say?

SMITH: This is a crucial question because as hard as it is to explain the economics, when you add diplomacy on top of that, it gets even more complicated. As a final voice, I wanted to talk with Caroline Freund. She's a trade expert with the Peterson Institute. And she says for the border adjustment tax to work, it needs to be explained rationally and calmly to other countries so they don't retaliate.

CAROLINE FREUND: Donald Trump needs to say that this is akin to what all the other countries in the world are doing with their value added taxes and that this border adjustment is standard and economic theory shows it's not protection. I think it really depends on the administration's talking points.

SMITH: On their points (laughter) - on their rhetorical discipline?

FREUND: This is - what I was going to say is I think this is what makes people even more nervous about this administration changing the tax code - is that from what we've seen so far - and, granted, it's only a week and there is a learning curve. But still, from what we've seen so far, I don't expect it to happen smoothly.

SMITH: You know, if this were a normal year, I would say that this tax has no chance of passing. We probably wouldn't even do a podcast on it because - think about it - there is a Wal-Mart in just about every congressional district. And it's hard to explain to your constituents that prices might go up for a while but they'll probably come down if the value of the dollar adjusts. I mean, that is just a political nonstarter.

But this is not a normal year. And weirdly, the stars seem to be aligning to take some sort of chance with taxes. Republicans want to pass something that looks like lower taxes. Donald Trump - he wants to pass something that has the word border in it. And as a result, economists may get to see what happens if you completely transform the corporate tax code. It's a sort of massive experiment to see if the real world acts the way the textbook says it will.

(SOUNDBITE OF MUSIC BOX PLAYING TCHAIKOVSKY'S "DANCE OF THE SUGAR PLUM FAIRY")

SMITH: What else can we explain to you?

GOLDSTEIN: Tell us on Twitter or on Facebook or by emailing planetmoney@npr.org.

SMITH: If you're looking for another podcast to enjoy, may we suggest the latest from NPR's Latino USA? In the most recent episode, it's about a Puerto Rican who was granted clemency in the very last days of Obama's presidency. Find Latino USA on the NPR One app or wherever you get your podcasts. Special thanks today to Alan Viard who we talked to and gave us some valuable information about this tax.

Today's show was produced by Nick Fountain. I'm Robert Smith.

GOLDSTEIN: And I'm Jacob Goldstein.

SMITH: Thanks for listening.

(SOUNDBITE OF MUSIC BOX PLAYING TCHAIKOVSKY'S "DANCE OF THE SUGAR PLUM FAIRY")

SMITH: There's no way to stop it.

GOLDSTEIN: (Laughter).

SMITH: What if the podcast is this just goes on for 20 minutes and we're like - we're out of here, folks.

GOLDSTEIN: Well, we have some way to - can we put it out of the room?

SMITH: No.

GOLDSTEIN: There's not a little switch?

SMITH: Well, it'll stop when the windy part.

GOLDSTEIN: Well...

SMITH: I don't know how to stop it.

GOLDSTEIN: ...Fountain has enough, right?

SMITH: Well, I know. But...

GOLDSTEIN: Sometimes there's a little latch.

SMITH: I know a music box works (laughter). I have a music box corporation.

(LAUGHTER)

GOLDSTEIN: Why don't you put latches on your music boxes?

SMITH: (Laughter) It's too expensive.

(SOUNDBITE OF MUSIC BOX PLAYING TCHAIKOVSKY'S "DANCE OF THE SUGAR PLUM FAIRY")

GOLDSTEIN: There. Doesn't seem too expensive now, does it? Transcript provided by NPR, Copyright NPR.