House GOP Tax Plan Aims to Boost Competitiveness, Might Also Violate Trade Law
The Fletcher School of Law and Diplomacy, Tufts University
The Issue:House Republicans have proposed a major overhaul of corporate taxes designed, in part, to make "Made in America" products more competitive abroad. The tax blueprint released by House Republicans in June is expected to be the starting point for the Trump administration’s tax reforms. And it is no mere tinkering. A key part of the reform would impose new taxes on imports and exempt U.S. exports from federal corporate taxes. The problem: this treatment of imports and exports could violate international trade agreements and, if enacted, might set us on the path towards a trade war.
- The House GOP tax reforms seek to remove incentives companies have to locate their production or headquarters overseas in order to reduce their tax burden. Part of this involves a sizeable rate reduction. The GOP plan proposes replacing the current 35% corporate income tax with a 20% rate applied to a “business cash flow” tax which is in essence a simplified definition of business net income (it takes gross receipts and subtracts gross expenditures other than interest expenditures).
- In addition, the plan would shift from the current system of taxing U.S. companies on their worldwide net income to taxing them on the basis of where their products are consumed. This means that the new tax would be applied to all goods consumed in the U.S., regardless of where they are made. But only U.S. businesses would be allowed to deduct their expenses. Thus, imports would be taxed the full 20% tax rate, while exports would be excluded from U.S. taxation.
- The ability to tax imports and exempt exports –known as border tax adjustments—is permitted under World Trade Organization rules, but only for taxes on a product, such as a sales tax (as opposed to income taxes). Many of the U.S.'s major trading partners tax imports while exempting exports because they have a system of what are called value-added taxes, which act like a sales tax on goods (but are collected in stages along the production chain). Value-added taxes are understood to be taxes on a product and are eligible to be border tax adjusted: they are rebated on exports and applied to imports as the product crosses the border.
- Relying on corporate income taxes has precluded the U.S. from applying similar border adjustments—a fact the GOP blueprint aims to rectify. But, whether the border tax adjustments in the blueprint are deemed legal from a World Trade Organization perspective will depend on a core interpretation: Is the tax in question an income tax or a tax on a product? While some argue that the business cash flow tax is economically equivalent to a value-added tax, legally it does not seem possible to characterize it as a tax on a product under the World Trade Organization rules. It is a tax on a firm, calculated by reference to firm-based attributes under a new and simplified definition of net income, but a definition of net income nonetheless.
- Moreover, imports would face 20% tax on their price with no deductions while domestic producers would be able to deduct most expenses — including payroll — from the tax base. This discriminatory treatment could also make the import border adjustment illegal under the international rules.
What this Means:
If the GOP tax plan were enacted, a World Trade Organization challenge to its border adjustments would lead to lengthy litigation. A (likely) ruling that the tax is an income tax, and is applied in a discriminatory manner, would mean that exempting exports would be considered an illegal subsidy and taxes on imports an illegal tariff. A negative ruling could lead to trade sanctions against the U.S. and open the door to counter sanctions and the start of a trade war. Perhaps the Republicans should reconsider a value-added tax instead.
For a more detailed legal treatment see here.