By: Seth Morris
Implementing a border adjustment tax as a way to decrease the United States’ trade deficit is not a new idea, but it has gained steam in Washington over the past several months. Republican House leadership first proposed a border adjustment tax last summer in their tax reform blueprint, “A Better Way: Our Vision for a Confident America.” Though he has been light on specifics, the U.S. President has consistently supported more aggressive tax reform—in the form of tariffs and export surcharges—to address the trade deficit.
Without a more specific plan, it is hard to predict where a border adjustment tax may run afoul of existing trade agreements. However, economists and other commenters are beginning to express concerns. At issue is a World Trade Organization rule that prohibits member nations from enacting tax policies that favor domestically produced goods over “like” goods produced in other countries. Any final proposal for a border adjustment will need to be narrowly tailored and carefully crafted in order to avoid these potential pitfalls.
What is a Border Adjustment Tax Anyway?
A border adjustment tax (BAT) is a destination-based tax levied on goods that is adjusted to negate its impact on domestic producers. The House Republicans’ current proposal is to levy the BAT in the form of a “value-added” tax on value that manufacturers add to their inputs (e.g. raw materials) by converting them into outputs. For example, under a regime with a 5% BAT, the U.S. Government would levy a tax of $5 on every $100 of value-added by a manufacturer, whether that manufacturer was a domestic producer exporting that good or a foreign importer. However, that tax would be “adjusted” via a $5 rebate or tax credit to the domestic producer.
The theory behind BATs is that, unlike tariffs which increase prices on imported goods without concerning domestic production, BATs apply taxes to imports and exports in a way that effectively cancels out any impact on trade overall. Under a BAT, the tax’s effects on trade are diluted in currency exchanges or wage adjustments. Ultimately, companies face greater incentive to produce goods for U.S. markets in the U.S. and have less incentive to shift profits around internationally.
What are the International Law Implications?
While economists on both the left and right have expressed support for a BAT, there are serious concerns that a BAT may run afoul of existing trade agreements.
There are three primary concerns regarding a BAT’s relationship with existing WTO rules:
- The WTO does not permit direct taxes and border fees on imported goods. However, the WTO does permit “indirect” taxes like value-added taxes. The current House proposal would align with this requirement, but a more aggressive, tariff-like approach would likely face a WTO challenge. Congressional leadership faces the challenge of crafting a plan that meets WTO standards while avoiding the ire of the Executive Branch.
- The WTO requires that BATs are applied equally to “like” imported and exported goods and that the BAT rate is no higher than the actual tax levied on the imported goods. A well-crafted BAT can avoid both potential conflicts. However, there is some concern that the House proposal would impose a lower tax rate on exported goods by permitting certain other deductions for domestic manufacturers. 
- Any BAT must be “borne by” the product being imported and be designed to ensure “neutrality” between imports and domestically produced goods. Again, House leadership will have difficulty crafting a plan that aligns with international law while being politically acceptable to the President.
These are not abstract concerns. In an early March interview, German Economy Minister Brigitte Zypries hinted at the possibility of a trade war if the U.S. adopted new taxes on German automotive imports. Minister Zypries stated that: “There are procedures laid out there because in the WTO agreements, it is clearly laid out that you’re not allowed to take more than 2.5 percent taxes on imports of cars.” Minister Zypries further indicated that any U.S. import tax could result in either retaliatory taxes by other nations or a lawsuit before the WTO. Japanese officials have also expressed concerns about the effects that a potential border tax might have on automotive imports.
In order for a BAT to have a successful path forward, U.S. policymakers must balance the political interests of a protectionist White House while avoiding future conflicts before the WTO. While a well-crafted BAT may pass international muster, it will require significant political compromise and must come with assurances to our international trade partners in an effort to avoid retaliation.
 U.S. House Committee on Ways and Means, A Better Way: Our Vision for a Confident America, A Better Way (June 24, 2016), http://abetterway.speaker.gov/_assets/pdf/ABetterWay-Tax-PolicyPaper.pdf [Permalink: https://perma.cc/MV6B-55VV].
 See, e.g., Donald J. Trump (@realDonaldTrump), Twitter (Feb. 3, 2017, 7:07 PM), https://twitter.com/realDonaldTrump/status/827715246135574530 [Permalink: https://perma.cc/GB6P-C28P].
 See, e.g. Scott S. Lincicome & Richard Eglin, Border-Adjustable Taxes under the WTO Agreements, WHITE & CASE (Jan. 19, 2017), https://www.whitecase.com/publications/alert/border-adjustable-taxes-under-wto-agreements [Permanlink: https://perma.cc/LY4V-2M3F].
 Border Adjustment Tax, Investopedia, http://www.investopedia.com/terms/b/border-adjustment-tax.asp [Permalink: https://perma.cc/8ZQS-RSZE].
 H. C., How America’s border-adjusted corporate tax would work, The Economist (Feb. 2017) http://www.economist.com/blogs/economist-explains/2017/02/economist-explains-9 [Permanlink: https://perma.cc/2DR8-DMUM].
 See Scott S. Lincicome & Richard Eglin, Border-Adjustable Taxes under the WTO Agreements, WHITE & CASE (Jan. 19, 2017), https://www.whitecase.com/publications/alert/border-adjustable-taxes-under-wto-agreements [Permalink: https://perma.cc/LY4V-2M3F].
 Vidya Kauri, Germany Could Sue US Over Border Tax On Imports, Law360 (Mar. 17, 2017), https://www.law360.com/articles/903410/germany-could-sue-us-over-border-tax-on-imports [Permalink: https://perma.cc/BU7N-EZHK].
 Stanley White & Izumi Nakagawa, Japan will tell United States to respect WTO rules: PM Abe adviser, Reuters (Mar. 1, 2017), http://www.reuters.com/article/us-japan-economy-trade-idUSKBN16837X [Permalink: https://perma.cc/36PC-S6Q3].