Border Adjustment Tax

The Donald has proposed a border adjustment tax (BAT).  We don’t like it.  We don’t like tariffs of any kind.  Jim Geraghty’s newsletter, Morning Jolt, references a study by Americans For Prosperity/Freedom Partners and has a quote that brings up some interesting accounting and tax issues related to BAT.  The quote goes (with paragraph breaks eliminated):

Consider a shoe retailer that imports the shoes it sells from a manufacturer in China. It buys a pair of shoes from the manufacturer for $50 and pays $10 in shipping costs. The retailer sells the shoes for $70, earning a $10 profit. Under the current tax system, the retailer would owe 35 percent in taxes on the $10 profit, because it would get to deduct the $60 it paid in business costs acquiring the shoes. The total tax bill would be $3.50. Under the proposed tax reform plan with a border adjustment tax, the retailer would pay a 20 percent (the proposed corporate rate) tax on the $10 profit, or $2. However, the retailer would also pay a 20 percent BAT on the $50 cost of the imported shoes, bringing the total tax bill to $12 — which is more than the retailer’s profit from the sale. It is easy to see how devastating a BAT could be for the retail industry, which faced with skyrocketing tax bills, would need to raise prices, cut jobs, or shut their doors altogether.

First, are the relationships right?  Clearly, shipping is too large at 14% and really stands in for other expenses.  Profits at 14% are probably too large.  Walmart makes 3% after tax and 4.5% before tax.  Cost of goods sold is closer.  For Walmart it is 75% and 71% in the example.  Walmart has an average tax rate of about 30%.  So the real news from BAT is even worse for Walmart and most retailers because few are making 14% on sales.  For Walmart, BAT would be $10.50 on what was previously a before tax profit of $3.15.  BAT is a bad idea but 20% seems like cruel and unusual punishment for importers and their customers.

Second, although shipping is way too large in the example, it is not trivial.  The question is: how would it be accounted for in BAT?  In generally accepted accounting principles (GAAP or financial accounting) shipping costs to the retailer are part of cost of goods sold for them.  If BAT did not include shipping as part of cost of goods sold then all of the purchases should be FOB shipping point (paid by the buyer) because that would allow the importer to reduce his cost of goods sold and BAT.

Like most taxes, BAT will lead to higher prices, less availability, costs related to tax avoidance.  Consumers will be much better off without it.  The Donald has done some good things but this would be a terrible mistake.

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