On Trade, The GOP Tax Plan Is Bonkers

Fundamentally, if you want to do something about the trade balance, it's problematic to focus on, rather than imports and exports themselves.
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The mooted GOP tax plan has drawn some positive attention from trade reformers because it's the first tax plan in decades to make serious moves designed to reduce America's trade deficit.

Unfortunately, unless I'm totally missing something, it's also a seriously crazy document.

So crazy, in fact, that despite not being an ultra-partisan fanatic, I am forced to the conclusion that either the GOP leadership is even stupider than ordinary political cynicism would assume, or the plan is simply not meant in earnest. (Is it a trap for Trump, to discredit him if he's foolish enough to buy into it? Dunno. A trap for the idea of tax-based trade reform? Ditto. But either of these hypotheses would make more sense than the idea that they actually mean it.)

Now it has many aspects, most of which I won't go into because its trade aspects alone are sufficient to rule it out as serious policy.

Here's why:

The GOP blueprint is basically a so-called "border adjustable cash flow tax," a/k/a a "territorial cash flow tax," a/k/a "destination based cash flow tax" (Twitter hashtag #DBCFT). Export sales are excluded from income, and imported products, services, and labor are not deductible.

The problem is that this results in a comically extreme disparity between the treatment of imported, domestic, and exported goods. Some examples:

1. Domestic goods: ACME, Inc. sells $100K domestically, with $80K costs procured domestically - result is $20K taxable income. Results same as now.

2. Imported goods: ACME sells $100K domestically, with $80K costs all imported - result is $100K taxable income because the imported inputs are not deductible.

3. Exported goods: ACME sells $100K to foreign buyers, with $80K costs all domestic - result is $80K tax loss.

So it's a hyper-aggressive subsidy for exports. Boeing can sell a $100 million airplane to Air France, make $20 million in profit, and yet book it as an $80 million tax loss. It's the biggest corporate giveaway I've ever heard of.

This is so aggressive it will prompt corporations to do transactions that make no sense, simply to capture the tax loss. Profitable companies will buy up any exporting company, just to harvest their tax losses.

It's actually not so bad on the import side. Basically, it would force companies to pay their effective corporate tax rate on the value of imported goods. The average corporate tax rate is about 13%, so this would imply approximately a tariff of that amount. (To be fair, the average tax rate on importers is considerably higher, because importing doesn't offer as many loopholes as, say, running a hedge fund, so the de facto tariff would be more.)

Fundamentally, if you want to do something about the trade balance, it's problematic to focus on profits, rather than imports and exports themselves.

For example, what happens when Delta buys the plane Air France just bought in the example above? Because Air France is making the profit on the sale of the plane, and outside U.S. jurisdiction, there's nothing to discourage this. So Boeing will "launder" all its sales this way. And why shouldn't Delta just buy from Airbus, which is similarly outside U.S. jurisdiction? This tax only has leverage against imports done by American middlemen with profits to grab.

So what would happen? Here's a real-life case that occurred to me the other day:

1. If I buy a pair of Chinese-made sunglasses from a stand on the Santa Monica Promenade, the landed cost of the glasses is not deductible to the guy who sells them to me, so he pays a very stiff tax for doing so.

2. If I buy the same pair over EBay from a guy in Hong Kong, there's no U.S. middleman to take a tax hit, so there's no disincentive to buy imported glasses.

Implication: a mad rush by consumers and businesses to establish "direct import" relationships with foreign suppliers. But this a) evades the tax and spoils the incentive, and b) has no rational economic purpose, so it undermines economic efficiency.

So put me on record this thing is probably too crazy to be real. It's quite likely House Speaker Paul Ryan is just using the public's current attention to the trade deficit as an excuse to get this plan in circulation with the real intention of dialing it back to something less kooky but still lavishly rewarding to his corporate sponsors.

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