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The Real Dangers of Border Adjusted Tax for Fashion

The proposed reforms could cripple any American fashion brand reliant upon importing goods and services from abroad.
Source: Shutterstock
  • Edwin Jiang

NEW YORK, United States — A key driver propelling Trump's ascent to the US presidency was his vow to protect and create American manufacturing jobs. However, when Speaker of the House Paul Ryan and House Ways and Means Committee Chairman Kevin Brady together proposed "A Better Way: A Pro-Growth Tax Code for All Americans" back in June 2016 — a plan, which in theory, does exactly just that — very few Republicans found a Trump presidency particularly likely.

Today, while the president remains somewhat dismissive of Ryan and Brady’s tax proposal, deeming it “too complicated” to enact, the latest incarnation of the plan, a so-called “border adjusted tax,” has earned the support of the Republican-controlled Congress, prompting fierce opposition from businesses both in the US and beyond.

What is it?

Though ‘border adjusted’ has become a buzzword for those debating the tax proposal, a great deal of confusion still shrouds the inner workings of the measure. And while Trump’s press secretary Sean Spicer has mentioned enacting a superficially similar 20 percent import tax on Mexican goods, the Republican-championed tax proposal has little, if anything, to do with Trump’s proposed border wall.

For one, the border-adjusted tax proposal is not only a trade tariff, or merely a tax on imported goods — something Trump repeatedly promised during the campaign trails. Sure, Trump often threatens economic rivals like China as well as American firms who refuse to re-shore with tariffs, but these border taxes are notoriously difficult to enact, tainted with the possibility of sparking a trade war. And though Trump’s “big border tax” may sound identical to the Ryan-Brady border adjusted tax plan, the two actually differ vastly in both in purpose and scope.

Trump’s “big border tax” is, in essence, merely punitive and comparatively simple. Targeting specific countries, goods or categories of companies who conduct businesses abroad, Trump’s tax seeks to punish those who manufacture abroad for the US market, presenting the situation as an incentive for businesses to re-shore manufacturing. In contrast, the border-adjusted tax does not only focus on companies who choose not to manufacture in the US. Instead, the Ryan-Brady plan is a radical undertaking that would vastly revamp the entire corporate tax code.

According to an analysis published by the American Enterprise Institute, a Washington, DC-based conservative think tank, currently, incomes earned by corporations are taxed at the shareholder/partner’s ordinary income tax rate; whereas, under the new system, corporate income would be taxed on a cash-flow basis. Under the Ryan-Brady plan, all itemised deductions would also be eliminated with the exception of mortgage interest and charitable giving. Effectively, these changes would abolish the right of importers to deduct the cost of goods sold (CoGS) from their tax liability. That is to say, not only would many companies have to pay their income tax, they would also have to pay an additional tax on the cost of their imported goods and services at the proposed rate of 20 percent.

Winners and losers

Many proponents of the tax plan believe that its enactment will help America become more competitive in the global marketplace. “A border adjustment tax should broaden the corporate tax base. It would be helpful to US companies that do a lot of exporting, but the US companies that do a lot of importing are likely to object to it,” says Ira Weiss, a professor specialising in tax strategy and entrepreneurship at the University of Chicago Booth Business School. “Based on what I know at this point, I would be in favour of a border adjustment tax. Right now, many top US corporations (including Apple, Google and others) have been able to avoid most of their tax liability by shifting their profits overseas.”

However, those who are against it see the tax plan as a hidden consumer tax that would ultimately be passed off to shoppers. “It is corporate tax reform on the backs on the American consumers. It is basically a hidden tax in the cost of everything from filling up your car to the shirt on your back to the shoes on your feet,” claims Thomas Nakios, founder of the Nakios Group, an investment holding company. Indeed, fashion companies, which do conduct a lot of importing, are categorically opposed to the proposals, evidenced by the formation of coalition against the measure comprising over 100 companies, both domestic and international, from Nike to LVMH.

For example, consider the three following simplified hypothetical situations under the new Ryan-Brady framework:

1. Manufacturer A produces garments in New Hampshire, where there is a 0 percent income tax, using “home goods” (or goods sourced in the US) to create product to be sold domestically. They generate $100 in revenue and spend $50 on costs of supplies and services. Since home goods are tax deductible, they pay 20 percent on $50 profits, which yields a tax of $10.

2. Manufacturer B produces garments in the same town, to be sold in the same retailers as A — but uses imported goods from China. B generates $100 in revenue and spends $50 on costs. However, their sourced goods are not tax deductible as they are foreign. Based on cash flow, they would have to pay 20 percent on their $50 profit as well as $50 costs, yielding a tax of $20.

3. A third manufacturer C is identical to A, except that they export their finished goods to be sold abroad in Europe. C generates $100 in revenue and spends $50 on costs; but their goods are wholly sold abroad. While similar to A, C reports $50 in profits, but their profits are sold outside of the country and thus receive a 100-percent tax exemption.

If you are located in a state like New York, where the apparel industry is concentrated, it is going to come to 44 percent.

Due to the nature of the tax and its popular nomenclature, many have been quick to analogously compare the GOP’s border adjustment tax to other border adjustments like the value-added tax, or VAT. However, this is, in essence, a false equivalence. Whereas VATs are not intended to be protectionist, the Ryan-Brady border-adjusted taxes are.

Fashion entrepreneurs like Nakios recognise the dangers of such rhetoric. “When I send my merchandise to the UK, I pay a VAT on import, but I am not at a competitive disadvantage because I pay that VAT,” says Nakios. “Because the reality is that a UK manufacturer who produces in the UK also pays a VAT on sales. Imports and domestic production have the same tax implications under a VAT system.”

Essentially, the cash-flow border adjusted tax that Republicans are proposing appears discriminatory, unlike VATs. Under VATs, both home goods and foreign goods will be subject to the same tax — the set sales tax of the specific state, for instance. However, under the GOP plan, taxes on clothing that is manufactured in the US using American-sourced goods will be significantly lower than those made from goods and services sourced abroad. That is to say, as it stands, the Republican plans effectively not only punish those who import goods from and conduct services outside the country, but is also skewed in favour of those who export goods abroad.

The Ryan-Brady tax reform, if it comes to fruition, will likely have, as Professor Weiss suggests, negative effects on the American fashion industry, an industry largely dependent upon the importation of foreign goods and services for the creation of products sold in the US market. It would severely punish the majority of businesses in the industry, which are more likely to resemble Manufacturer B than C, or even A.

Furthermore, the damage seems especially harsh on fashion, whose operations are concentrated in specific US geographies. Indeed, income taxes in the centres of America’s fashion industry, New York City and Los Angeles, are significantly higher than in the rest of the country, and certainly higher than in New Hampshire, adding salt to the wound. “If you are located in a state like California or New York, where the apparel industry is concentrated, at least in New York City, it is going to come to 44 percent and similarly in California, because California has a top personal rate of 13.3 percent,” adds Nakios.

And while some economists argue that the negative consequences of the border adjusted tax will be offset by the appreciation of the dollar, whereby the new tax would encourage exports and discourage imports, it is uncertain at this point just how sustainable this appreciation will be, and whether it will even have a positive effect on the US manufacturing jobs that Trump touted in the first place.

“I’m in NYC paying 44 percent — if the dollar goes up enough to neutralise this tax expense, it means we have a super dollar," says Nakios. "The dollar is already trading at historic highs — or at least recent-term highs. If a dollar surges that much more, how does that make US manufacturing more competitive in the global market place?”

Related Articles:
In US, Retailers Up Fight Against Republican Tax Proposal

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