Briefing Book

Pass the Popcorn for Republican Tax Reform

On the fallacy of Trump’s so-called “border adjustment tax,” and the Republican civil war it might spark.

By Max B. Sawicky

Tagged InequalityRepublicansTaxes

The history of the world used to be the history of class struggle. Now the history of the world seems to be the back-and-forth over the taxation of the 1 percent. Over the decades, federal income tax rates have changed less for the vast middle class than they have for the rich. In the fabulous 1950s, the top marginal rate in the personal income tax was 91 percent. Now it’s just under 40 percent. Meanwhile, the contribution of corporate income taxes to federal revenue has gone down while that of the payroll tax has gone up. And I needn’t have to remind you that the share of pre-tax income claimed by the rich has skyrocketed.

This has been a bipartisan exercise, but for the Republican Congress, the work of lubricating the lubricated is still not done. Under the Clinton Administration, budget deficits were fought at great political cost and eliminated by the end of the 1990s. This amounted to a swell gift to the incoming Republican Administration after the (s)election of 2000: namely, an opportunity to cut taxes and jump the deficit right back up. Which of course they did.

Now here we are, in 2017, after the Obama Administration has brought the deficit down from $1.5 trillion in Fiscal Year 2009 to $621 billion in FY2016, again at great political cost. You don’t have to think very hard to guess what the Republican majority in Congress is up to next. But there is still one problem.

The Republican Congress came in on the coattails of a different kind of Republican. While Donald Trump has been surrendering his populist commitments like clockwork, he appears to still be of a mind to do something about trade, an issue which might have been his strongest political card in the primaries and general election. He has undone Obama’s Trans-Pacific Partnership, the infamous TPP, but he is half-stepping on killing the North American Free Trade Agreement. Moreover, replacing a single omnibus trade deal like the TPP with a plethora of individual deals, one country at a time, will be a gargantuan, time-consuming task, of which the results will likely be a long way into the future. What’s left? Taxes. And the President has decided that he wants to tax imports.

The leading vehicle for Trump’s efforts to advantage U.S. manufacturing is the so-called “border adjustment tax,” known to wonks as the “Destination-Based Cash Flow Tax” (DBCFT). Since there seem to be no plans to invade Mexico yet, it is not the border that would be adjusted, just the taxation of imports and exports.

Less remarked about the DBCFT is that it repeals-and-replaces the U.S. corporate income tax. More specifically, it eliminates the tax on most corporate income and, supposedly, recovers the revenue by taxing imports. Yet the effective tax rate on capital (dividends, interest, rent, capital gains) is reduced to zero. It is truly the populism of fools.

The fun part is that to minimize the increase of federal deficits, after Trump’s months of ranting about the national debt, the DBCFT makes itself affordable by goring the ox of firms in the business of selling imported goods. This includes all the big retailers such as Walmart and Target, but also industries that import raw materials for further processing. Among the latter is the petrochemical sector. What this means is that the DBCFT is setting off a civil war among conservative tax-cutters.

The sides line up roughly in the same way they did for health care. The border tax was hatched in the House under the tutelage of House Speaker Paul Ryan. The White House, especially trade militants like Steven Bannon and Peter Navarro, is on board. On the other side is a parade of astro-turfy opposition groups and allied corporate interests, including the formidable Koch network. Sound familiar? This was the same gang that killed Ryan’s replacement for Obamacare. So we have reason to think we may already know how this will end.

A relatively accessible discussion of the DBCFT by Alan Auerbach and friends can be found at the Center for American Progress. Auerbach describes it compactly (and misleadingly, see below) as “a tax on consumption from sources other than wages and salaries.” This description may actually appeal to some liberals. Like the original Hall-Rabushka flat tax, it’s actually an elegant idea. It simplifies the taxation of corporations and it might reduce tax avoidance. It could raise a great deal of money if the tax rate is kept close to the current one.

On the minus side, it makes the distribution of the tax burden less progressive, and under Republican authorship it is unlikely to raise any net revenue. If history is any guide, we can count on the contrary. Oh, and the DBCFT is probably illegal under existing trade agreements.

But, more than that, Auerbach’s claim that the tax only falls on consumption by recipients of capital income (dividends, interest, rent, capital gains) is misleading or wrong for four reasons:

  1. The notion that wages escape taxation rests on the counterfactual wherein wages are part of the firm’s tax base, as under a value-added tax (VAT). But the actual counterfactual in force is the U.S. corporate income tax (CIT), which does not include wages in the tax base. Compared to the CIT, there is in fact a shift in tax burden to wages used for the consumption of imports.
  2. At the time the new tax takes effect, those who have savings based on wages do in fact bear the tax insofar as they purchase imported goods, or goods that require imported materials for manufacture. Only until they are all literally dead will it be true that, in Auerbach’s sense (but see #1), only non-wage income is taxed when it is used for consumption.
  3. Those with non-wage income who are not necessarily rich recipients of capital income, such as food stamp beneficiaries, also bear the burden of the tax on imports.
  4. So too do workers bear the burden of the tax who reap above “normal” returns to investments based on their wages.

In summary, Paul Ryan’s tax cut vehicle is a target-rich environment for critics, many of whom will be found in his own caucus. Nor can he expect much relief from his Democratic counterparts.

Make that with butter but no salt, thanks.

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Max B. Sawicky is a writer and economist in Virginia. He co-edits ThePopulist.Buzz with Bob Dreyfuss.

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