Paul Ryan's Tax Plan May Not Do What Trump Says It Will

The president appears to be considering a border adjustment tax, which many economists favor. But its supporters warn it won’t give him what he wants.

For as loudly as Donald Trump complains about foreign trade, it’s hard to pin him to specifics. Does he prefer a 20 percent tariff on Mexican imports? Or a 45 percent tax on companies that move jobs overseas? Or… something else?

On Thursday, the president made his position a bit more clear. In an interview with Reuters, he praised a proposal by House Speaker Paul Ryan to broadly tax imports but remove taxes on exports, a core component of the Republican “Better Way” blueprint.

Ryan wants the “border adjustment” as part of a larger refactoring of the American tax code, something fiscal conservatives have sought for a long time. But Trump doesn’t appear to care about tax reform. He just wants domestic job growth.

From Reuters:

"It could lead to a lot more jobs in the United States," Trump told Reuters in an interview, using his most approving language to date on the proposal.

Trump sent conflicting signals about his position on the border adjustability tax in separate media interviews in January, saying in one interview that it was "too complicated" and in another that it was still on the table.   

Economists differ on the particulars of the border adjustment tax (known more precisely, but even less sexily, as the destination-based cash flow tax). Some people like it, and some don’t. Every expert I spoke with agreed on one point, however: If Trump is looking to make new jobs, this isn’t the way to do it. Indeed, he may be expecting the economically impossible.

What is the BAT?

My colleague Bourree Lam has written two good stories explaining the BAT, also known as Not A Tariff, and Michelle Cottle has covered the political fight. I’m also partial to this graphic from The Wall Street Journal, which lays out a series of hypotheticals and walks readers through the math.

Here’s my stab at describing the thing:

• Right now, the U.S. government levies taxes on all corporate profits, no matter where the goods are made, or who buys them. If you’re making artisanal wooden tables in Pennsylvania and selling them in Ohio, you’ll owe 35 percent of your profits in taxes.  If you’re importing German cars from abroad and selling them in Kentucky—same thing, 35 percent. Heck, even if you’re making master-crafted broadswords in Ireland and selling them at Canadians renaissance fairs, you still pay 35 percent, as long as your corporate headquarters are based in the United States.
• The first thing the border adjustment tax does is require a business to pay taxes on the value of anything it brings into the country from abroad and later sells to Americans. Our artisanal table guy is OK—he’s using sturdy Pennsylvania wood, no importing required. But now, our Kentucky car importer isn’t just handing over 35 percent of her profits in taxes—she also has to pay 35 percent of the wholesale cost of the German cars, too. Eek!
• But there’s a consolation prize. If you’re selling something to foreign buyers, you no longer have to pay any taxes at all. Our Delaware-incorporated, Irish broadsword manufacturer can hawk to its heart’s content in Canada, because it isn’t selling to Americans. And if our Pennsylvania woodworker decided to sell some tables in Mexico, he wouldn’t pay any taxes on them, either.

At first, this may seem unfair to importers.They have to pay a bunch of new taxes, and unless they’re selling things abroad, they’re stuck with all the old taxes, too. But for the millions of workers who saw their jobs go overseas, this could be exciting: Finally, those greedy corporations are getting their comeuppance. They thought they were saving money by moving production to Mexico? Now they have to pay up!

If the story ended here, that’d be correct, and the import tax would likely encourage American companies to manufacturing things domestically (and also raise prices dramatically). This is what Trump wants.

But it’s not over yet.

The ever-flexible U.S. dollar

Kyle Pomerleau is the director of federal projects at the Tax Foundation, a nonpartisan think tank that sometime leans right. William Gale is co-director of the Tax Policy Center, a nonpartisan think tank that sometimes leans left. Leanings aside, both men agree on pretty much everything about the border adjustment tax, especially on one point—the tricky American dollar will ruin Trump’s plan.

The dollar doesn’t have a fixed value—it goes up and down, relative to other currencies. And if Congress passes Ryan’s plan, most economists expect the value of the dollar to go up (for reasons just complicated enough to warrant skipping over here). This will make imports cheaper—cheap enough that the new tax doesn’t really matter.

“The way I think about it, the currency adjustment is paying the tax,” Pomerleau said.

“My view is that the exchange-rate adjustment will be relatively substantial and relatively quick,” Gale agreed.

At the same time, the stronger dollar makes the prospect of tax-free exports a bit less exciting. Sure, our Pennsylvania woodworker isn’t paying any taxes on his sales to Mexico—but since the dollar has appreciated in value against the peso, Mexican decorators can’t afford to buy as many tables. So the woodworker brings in less revenue.

In short, it’s a wash. To spur domestic manufacturing growth, Trump wants to put pressure on imports. But because of the floating U.S. dollar, Paul Ryan’s plan probably won’t give it to him. He’s barking up the wrong tree.

Not that economists particularly care. “It’s possible to support a good policy for a bad reason,” Pomerleau said.

But it might be a bad policy

Not everyone is convinced the Ryan proposal will work as planned. Right now, the retail industry is in a state of hyperventilation; a number of larger importers, including Walmart and Toyota, have joined a coalition opposing the plan. Many fear the promised currency re-evaluation might arrive too slowly, or never come at all, leaving importers with a crushing tax bill.

One man who holds this belief is Rick Helfenbein, the president and CEO of the American Apparel & Footwear Association. Helfenbein help create Le Tigre; before joining AAFA, he headed the U.S. operations of a major Asian clothing manufacturer. In all his years, he’s never seen the strength of the U.S. dollar as having much of an impact on his bottom line, largely because his supply chain always accepted American currency, and rarely dealt with local fiat.

“We buy in dollars, we live in dollars, we sleep in dollars,” he said. “I think in theory, [the economists] probably get it right. But in practicality, they’re probably getting it wrong. If you phase this in over a 10- or 20-year period, maybe the currencies would have time to adjust. But the way a Trump tweet works,” and here he laughs, “they’re going to want to do this tomorrow.”

So if the American dollar doesn’t bulk up as expected, what happens? Exporters might be happy—they’ll be able to move a lot of product with no taxes. But importers will take a bath, and America imports a lot of things. The first to be hit will be clothing brands—97 percent of all clothes and 98 percent of shoes are shipped in from abroad. Faced with a big tax bill, they’ll increase prices to compensate, which will bubble up to the retailers. Customers will buy fewer clothes, and maybe some stores will close, taking their jobs with them.

But that’s not all. A hefty proportion of imports go directly to American factories, who use them to make new things. A prime example is the auto industry, which relies extensively on Mexico for car parts. For every car built in the United States, a quarter of its parts were imported from outside the country; the Chevy Silverado alone gets more than half of its components from overseas. With those parts marked up because of the tax, cars themselves become more expensive—and workers risk losing their jobs when demand drops.

Economic theory says this won’t happen, because of the dollar’s flexibility. The GOP’s plan does contain other sweeteners, most prominently a cut in the corporate tax rate to 20 percent and changes to how businesses deduct equipment expenses. But either way, it’s hard to see how Trump wins. If Ryan’s proposal works as planned, the world economy’s relentless swerve toward equilibrium would make imports cheaper and erase any economic pressure to move jobs to America. And if the plan goes off the rails, the economy will likely be hit so hard that no one will be celebrating the fact that America is making stuff again.