Are President Trump’s tariffs a less effective and more ad hoc version of the border adjustment tax (BAT) that briefly surfaced, then died, during last year’s debate over the Tax Cuts and Jobs Act?

You remember the BAT, perhaps the most controversial element of the late Destination-Based Cash Flow Tax. It was a key component of the original House version of the Tax Cuts and Jobs Act, but died in the face of opposition from US retailers, key senators, and eventually President Trump. It was killed, in large part, because critics said it would raise the prices US consumers paid for imported goods.

Rising consumer prices

Now, we are in the early stages of a trade war that likely will raise the prices US consumers pay for both imported and domestically produced goods.  Just yesterday, Trump announced a new round of tariffs on $200 billion in Chinese-made goods, including consumer products ranging from dog leashes to components of flat panel displays.

Trump himself seemed to blow hot and cold over the BAT, as did different members of his administration. But the president’s gut reaction was never favorable. This is what he told The Wall Street Journal in January, 2017; “Anytime I hear border adjustment, I don’t love it. Because usually it means we’re going to get adjusted into a bad deal.”  

Death of the BAT

Thus, the BAT died. But now the president has imposed tariffs on steel and aluminum imported from most of our major trading partners including the European Union, Canada, Mexico, and China, along with a growing list of other products from China. In a predictable response, all those nations have announced retaliatory tariffs and other sanctions on a laundry list of US exports.

The almost certain result: higher consumer prices in the US for goods subject to the tariffs. Not just for finished goods purchased from foreign manufacturers, but from products Americans buy from US firms, such as autos and cell phones, that include overseas components that are subject to Trump’s tariffs. For example, when tariffs raise the price of steel, they boost the price of US-made nails.   

Even prices of fully Made In America goods likely will rise, thanks in part to reduced competition from foreign products.

Different goals

The BAT would have been based on where products were consumed, not where they were made. It would have barred US firms from deducting the costs of all imported goods and services.  However,   income from products sold overseas would have been exempt from US tax, even if they were made domestically. As a result, the BAT would have largely neutralized the tax treatment of cross-border transactions.

Tariffs don’t increase US tax on exports but trade wars boost foreign taxes on goods and services made in the US and sold overseas. Thus, the cost to US based firms (and their consumers) rise.

While the BAT and tariffs both tax imports, their goals could not be more different. The BAT was intended to reduce business tax avoidance by linking US tax to where a product is sold rather than the residence of the business or the source of its profits.  It was not intended to discriminate against specific goods and services or specific countries. Crucially, there would be no presidential discretion when it comes to deciding what is taxed and what is not.

Picking winners and losers

In contrast, tariffs are explicitly designed to protect selected industries in the US by reducing imports from targeted countries. And, especially as imposed by the current Administration, they give the president enormous power to pick winners and losers. 

While tariffs normally are approved by Congress, President Trump has proposed these on his own, based on weak claims of national security. And he has not been shy about using import taxes for domestic political purposes or to achieve non-economic geopolitical goals.

While the BAT was intended to increase the tax efficiency of trade, tariffs make trade less efficient. Rather, Trump sees them as a weapon to win economic or political battles. Trade wars, the president tells us, “are easy to win.”   

Adam Smith knew

Most countries have border-adjustable value-added taxes that are similar to the Destination-Based Cash Flow Tax. However, no other country has adopted the exact design of the DBCFT and we don’t know how it would have worked in practice. Tariffs, unfortunately, are not new. And as Adam Smith concluded nearly 250 years ago, there are no winners in trade wars.

Yet, President Trump, who rejected a tax reform that was intended to be trade-neutral, has gone all-in on tariffs.  This may give him a tool to reward friends and punish enemies but it will neither improve the US tax code nor strengthen its economy.