Austaxpolicy blog

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US Republican tax plan: The potentially dire impact on US retailing.
20 February 2017, by Michael Potter

The US Republican party is proposing substantial changes to the US corporate tax system, which President Donald Trump supports with some reservations. The headline change is a slashing of the corporate tax rate from 35 per cent to 20 per cent. There is plenty to say about this, including how it will make Australia’s 30 per cent rate much more uncompetitive.

But the Republican tax plans contain a number of other major parts. This article focusses on two: removing tax deductibility for imports, and providing a tax exemption for exports. These components are together called ‘border adjustment’, and it is this that President Trump is concerned about — although it has some similarities with his proposals for a substantial tax on imports from Mexico.

The overall effect of the tax changes, including border adjustment, would transform the US corporate tax into what is essentially a GST with a credit for wage costs or a GST combined with a cut in payroll tax. Many commentators argue that the plan as a whole (technically called a Destination Based Cash-flow Tax or DBCFT) will reduce tax avoidance by removing the biases towards debt financing, profit shifting and transfer pricing.

However, border adjustment will also create new tax avoidance possibilities, and will undercut many US retail businesses. These harmful effects potentially outweigh the benefits of the tax change.

If Walmart buys a TV from China for US$200, it currently claims this as a tax deduction. If border adjustment is introduced, this deduction would be cancelled. At a 20 per cent tax rate, imports would be about 20 per cent more expensive for American businesses. Unsurprisingly, retailers have complained about this substantial impost. They will need to hike prices by about 20 per cent if margins are to be maintained and the exchange rate does not move.

But the exchange rate will move to offset border adjustment, according to supporters such as Martin Feldstein. They argue the US exchange rate will move to fully offset the tax increase, with a 25 per cent appreciation offsetting a 20 per cent tax on imports (see a worked example here). This appreciation would supposedly mean there was no need for Walmart to change its prices.

Read the full article at Austaxpolicy blog.

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