Opinion: This is a straightforward way to fix trade without using Trump’s tariffs
Paul Ryan’s plan would lower taxes for exports and reduce advantages for imports
Republican presidential candidate Donald Trump has been criticized for proposing to reform trade agreements and to place tariffs on some imports.
But House Speaker Paul Ryan’s corporate tax plan offers an elegant way to help the unbalanced trade situation without the word “tariffs.” By using expensing, a territorial tax system and border adjustability, exports would face lower taxes and imports would lose their tax advantage. This would encourage companies to increase production in the United States and reduce it abroad.
What is Ryan’s plan, and how would it fill the role of a tariff? Ryan proposes a move to a territorial tax system and a system of border adjustability. This would mean that exports would be encouraged and imports would be penalized. Currently, a business that imports an input for its production process can deduct the cost of that input. Under border adjustability, this deduction would no longer be allowed.
American companies are at a disadvantage relative to those in other countries, which explains the rash of inversions and the efforts of the U.S. Treasury to stop them.
In addition, the speaker would reduce the corporate tax rate to 20%, lower than the Organisation for Economic Co-operation and Development (OECD) average of 25%. Interest would only be deductible against interest income, but with unlimited carry-forwards. Many deductions, such as the Section 199 domestic-manufacturing credit, would be eliminated.
The combination of tax incentives created by the corporate tax plan and border adjustability would attract some of the more than $2 trillion in offshore earnings back to the U.S. — and keep them there.
Unfortunately, the United States now has an export penalty and import subsidy. The Ryan tax proposal flips this to produce an export incentive and import penalty because of its destination-based tax and territorial system. It would end the problem of inversions, which are partly caused by trapped cash overseas and U.S. rates that are higher than those in other countries.
In practice, the border-adjustable value-added tax (VAT) used by European countries offers rebates to companies exporting goods so that the tax system incentivizes businesses to export rather than create disincentives. Of course, U.S. exports would still be subject to destination-based VATs in other countries. Taxes are also levied on imports from foreign countries at the same rate as American goods would be taxed abroad.
Border adjustability taxes are essentially tariffs under another name. They incentivize exports and punish countries that do not tax their goods at the same rate as the home country by eliminating their “unfair” competitive advantage. The reason that they do not harm trade like a conventional tariff is because the tax rate at each destination is the same for domestic and foreign goods, thus the OECD refers to it as a “neutral” policy.
One question that arises is whether border adjustability is legal under World Trade Organization regulations. It is clear that waiving the tax on exports is legal, but what about disallowing a tax on imports? However, other countries use the same system with their value-added taxes. Under many forms of VATs, taxes are refunded when products are exported, and are imposed on imports. This is not the case under the current U.S. corporate tax system.
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In fact, the United States now has the reverse: Exports bear the cost of the U.S. income tax and imports do not get taxed. This is a penalty on exports and a subsidy to imports. Ryan’s corporate tax plan would reverse this.
The Ryan plan could help stanch the declining support for free trade. Many other countries have indirect taxes such as value-added taxes that are refunded on exports and levied on imports. Now, unlike companies in most other countries, American companies pay less tax when they import than when they export.
The current system puts American companies at a disadvantage relative to those in other countries, which explains the rash of inversions and the efforts of the U.S. Treasury to stop them.
Ryan’s plan would not only repair the broken corporate tax code but eliminate the trade bias, which has led more Americans of both parties to support the reduction of free trade. The burden of the extra corporate tax falls on both American capital and labor. No wonder Americans feel abused and disadvantaged.
The combination of a territorial system, full expensing of capital investments and border adjustability would help to restore the trade balance and stimulate gross domestic product (GDP) growth.
It is difficult to overstate the importance of a sensible tax system to economic growth. Real GDP grew at an annualized rate of about 1% in the first half of 2016. Indeed, failure to take into account the deleterious effects of higher taxes is one of the major reasons actual GDP growth has consistently underperformed the Obama administration’s expectations.
Corporate taxes are especially harmful. According to research by American Enterprise Institute resident scholars Kevin Hassett and Aparna Mathur, higher corporate taxes reduce wages. They conclude that a 1% increase in corporate taxes leads to a 0.5% reduction in wage rates in the manufacturing sector. Additional evidence suggests income losses due to corporate taxation are felt equally by low- and high-skilled workers.
Both Ryan and Trump see that the U.S. corporate tax system disadvantages domestic manufacturing in favor of foreign manufacturing. With a 1% GDP growth rate, it is time for change.