Why a Border Adjustment Mechanism is a Bad Idea

The Tax Cuts and Jobs Act (TCJA) of 2017 contained many well-crafted provisions for tax relief for individuals and businesses. But importantly, and less often mentioned, lawmakers also weeded out some ill-conceived policies from the final bill. One such rejected proposal was a so-called “destination-based cash-flow tax,” or border adjustment mechanism (BAM) – formerly known as a border adjustment tax. A part of then–Speaker of the Houses Paul Ryan’s 2016 tax plan, the BAM (had it been enacted) would have taxed businesses (foreign and domestic) on production consumed stateside; meanwhile, American exports would have received exemptions.

Nearly a decade on, the BAM is making a comeback. Its loudest advocates today are protectionists. They say it would serve a tariff’s function, benefitting domestic producers. Moreover, it seems to many an attractive revenue source.

The BAM’s appeal rests on dubious suppositions and unsure projections. First off, the BAM’s advocates often misstate the international tax ecosystem American businesses inhabit, offering it as a cure to an imagined disease. As two scholars from the Heritage Foundation made the case in a recent op-ed, American exporters supposedly submit to double taxation – once, in America, upon production; and again, abroad, in the form of consumption taxes. Foreign businesses are said to be taxed only once.

This is, quite plainly, bunk, as economists Veronique de Rugy and Daniel Mitchell outlined back in 2017. They wrote:

Proponents of the border-adjustment tax also are using a dodgy sales pitch, saying that their plan will get rid of a “Made in America Tax.” The claim is that [value-added taxes (VATs)] give foreign companies an advantage. Say a German company exports a product to the U.S. It doesn’t pay the American corporate income tax, and it receives a rebate on its German VAT payments. But an American company exporting to Germany has to pay both – it’s subject to the U.S. corporate income tax and then pays the German VAT on the product when it is sold.

Sounds horribly unfair, right? Don’t be fooled. Like magicians, those making this argument are distracting the unwary, hoping that nobody will notice the trick.

Here’s the real story: What matters from a competitive perspective is whether the playing field is level – and it is. When the German company sells to customers in the U.S., it is subject to the German corporate income tax. The competing American firm selling domestically pays the U.S. corporate income tax. Neither is hit with a VAT. In other words, a level playing field.

What if an American company sells to a customer in Germany? The U.S. government imposes the corporate income tax and the German government imposes a VAT. But guess what? The German competitor selling domestically is hit by the German corporate income tax and the German VAT. That’s another level playing field. This explains why economists, on the right and left, repeatedly have debunked the idea that countries use VATs to boost their exports.

After conjuring this psychosomatic disease, BAM supporters proceed to another obstacle. It is, simply put, bad policy.

Economists differ with respect to a BAM’s likely effects. In theory, a perfectly applied BAM would cause the dollar to appreciate, affecting trade flows not at all and frustrating protectionist policymakers. “The adoption of a border adjustment by the United States would trigger an increase in the real exchange rate that would offset the perceived boost to exports and the perceived restraint on imports,” Alan D. Viard wrote for the American Enterprise Institute. Viard continues: “[T]he main conclusion of the simple textbook model carries over intact to more general and more realistic models.” However, even were the theory to manifest cleanly in practice, a BAM would likely prove a veritable fountain of unintended and injurious consequences.

Other economists believe that confounding factors – unpredictable human responses, carveouts for politicians’ favorite industries, and more – would disrupt a BAM’s implementation. Myriad political and economic distortions seem likely, none impending anything good. So argues Adam Michel, director of tax policy studies at the Cato Institute. “While these effects are far from certain,” he writes, his “analysis…suggests [the protectionists’] assessment is directionally correct.”

All this creates an inescapable tension. “Policymakers ultimately can’t have it both ways,” Michel continues. “The border adjustment is either tariff-like – and currencies do not fully adjust – or it is trade neutral and thus will not meet the policy priorities of mercantilist advocates, leaving them to desire additional tariffs in the future. The new border tax is bad either way.” Should a BAM function as a tariff, it would likely impose severe economic costs, which the Taxpayers Protection Alliance has documented at length.

Lawmakers seeking to aid American businesses have far better policy reforms within reach. They might further slash corporate tax rates, renew the TCJA’s tax credits for research and development, and repeal burdensome red tape. Calvin Coolidge famously said, “It is much more important to kill bad bills than to pass good ones.” Likewise, it is often more important to undo foolish regulations – allowing private businesses to thrive, free of interventionism – than to dream up new heavy-handed policy interventions to tilt the economy in one direction or another. As another great Republican president said, “the nine most terrifying words in the English language are: I’m from the Government, and I’m here to help.” This applies irrespective of whether those in power are Democrats or Republicans.