House Republican Tax Plan Would Make Imports Taxable, Exempt Exports, Raising WTO Concerns

Among the changes being discussed are that the cost of imports would no longer be included in the importer's cost of goods sold (COGS) and subtracted from net income, Schultz said. That would mean the cost of the imported product would be added to the company's taxable income, she said. The “Better Way” blueprint is general and doesn’t clearly mention full denial of import tax deductions as a mechanism to boost U.S. competition in international trade, Schultz said. “Rather it talks about adopting a ‘cash-flow based approach’ replacing an ‘income based approach,’ thereby allowing taxes to be imposed on a destination basis,” she said in a Nov. 29 email. “This means that they could rebate some share of income taxes on exports and assess them on imports, but there is very little in the actual document about how it is calculated.”

Under the plan, the committee would maintain business income taxes, but try to steer clear of violating World Trade Organization rules barring border-adjustable income taxes with respect to exports by employing a “consumption-based” tax approach. To be sure, there is nothing in the committee proposal suggesting a removal of the income tax structure as it relates to imports and exports, Schultz said. Other tax and trade analysts we spoke to declined to weigh in given the uncertainties around the actual language and political sensitivities. "Movement toward a consumption-based system need not involve a shift to an explicit consumption tax, such as a retail sales tax, but instead could result from reforms which exclude certain features of the income tax base," the plan says. "Those changes would achieve similar economic results albeit through different administrative rules."

It is still unclear how the committee could assess border-adjustable income taxes yet avoid inviting scrutiny at the WTO, Schultz said. Export tax rebates are considered illegal export subsidies under WTO rules unless the rebates are of indirect taxes like VAT. “You can call it whatever you want, but if it is based on income rather than consumption, it is discriminatory and not permitted under the WTO,” Schultz said in an email. “If they do make it a consumption tax, it would be WTO-legal, but then it would be paid by the end customer, not the importer as an income tax.”

Any legislation denying deductions for cost of goods only for imported products would violate WTO "national treatment" rules under Article III of the General Agreement on Tariffs and Trade that require countries to treat foreign goods as favorably as domestic goods, Schultz said. “That article has a very long and clear history in WTO jurisprudence, and I have little doubt that such a GIANT and discriminatory change as denying deductions for imported products would be ruled illegal,” Schultz said. "I think one of the basic misperceptions is that this would be no different than what other countries do by imposing their VAT or excise taxes on our products when they cross their borders. But the difference is that those taxes are also imposed on domestically produced goods and therefore do not violate Article III," she said. “It would open the US to massive retaliation.”

Speaking at the Heritage Foundation Dec. 1, Ways and Means Committee Chairman Kevin Brady, R-Texas, said that Ryan’s blueprint, endorsed by his committee, proposes to “match” the trade-related tax approaches of China, Europe and other major U.S. trading partners. All major U.S. trading partners maintain border-adjustable value-added taxes, entailing export tax rebates and import taxes, according to the blueprint. The U.S. doesn’t have such a VAT system, disadvantaging the posture of U.S. exports, the blueprint says.

“We propose to take taxes off of Made-in-America products being sold around the world, and put them on imports coming into the United States,” Brady said. Border adjustability will help remove international competition off of a tax code basis and put it on a price, service and quality basis, he said. The border adjustability approach would also allow the U.S. to “dramatically” simplify the “stunningly complex” international tax code and, combined with the lower tax rates and territorial system described in the blueprint, border adjustability will act to eliminate every tax incentive to move “jobs, innovation, or headquarters” overseas, Brady said. “In fact, our goal is not simply to stem the tide and stop businesses in America from locating overseas; our goal is to bring those investments back,” Brady said.

The office of Sen. Ben Cardin, D-Md., a member of the Senate Finance Committee, said in a statement that while he strongly favors a border-adjustable trade tax framework, big questions remain as to how implementation of that type of provision would affect other countries’ treatment of the U.S., because the concept applies to corporate income, not consumption taxes like a VAT. Sen. John Thune, R-S.D., another Finance member, in a very brief interview Dec. 1 said he believes rejiggering the U.S. export and import tax framework will be a priority for President-elect Donald Trump after he takes office.