House Ways and Means Committee Chairman Kevin Brady, in response to strong opposition to his proposed border-adjustment tax, is now proposing a phase-in over 5 years. While this could satisfy those whose opposition was due merely to a fear of dramatic change to the tax code, it does nothing to address the substantive concerns offered by CF&P and others. Most notably, that it undermines tax competition and sets the stage for explosive government growth by introducing a VAT-like tax to the U.S.
Not only does it ignore the biggest issues with the BAT, but a phase-in introduces problems of its own. Here’s what Veronique de Rugy had to say:
Leaving aside the distortions and uncertainty that phasing in the tax will introduce, I doubt that it makes adopting the border-adjustment tax more politically feasible. Let’s talk about the trade deficit for a moment.
What do you think importers will do when they know that the tax today is at a lower rate than the tax tomorrow? They will anticipate tomorrow’s rate hike by importing more today and still raising costs tomorrow. How about exporters? If they think it is advantageous to delay exporting to benefit from a bigger export subsidy tomorrow, they will. You end up with a bigger trade deficit, at least in the short term. I am pretty sure that won’t fly with the trade-deficit obsessed Trump administration.
The ultimate problem, which a phase-in does nothing to solve, is that Republicans chose a bad policy to supply the revenue offsets for otherwise beneficial tax reforms. Clearly, the best solution is to replace it with good policy. That’s precisely what CF&P President Andrew Quinlan suggested to Ways and Means in a recent submission:
Although some arguments have been put forward to suggest that the DBCFT is desirable in its own right, it is only being proposed as a “pay-for” to offset the provisions of tax reform that are actually pro-growth. But even if it is decided that offsets are necessary, it makes little sense to choose a bad policy to pay for tax reform when there are alternatives available that also represent good policy…
Current reform plans rightly call for the elimination of the state and local tax deduction. This is good policy because the deduction encourages states to raise their tax burdens. However, other distortion-creating tax expenditures remain unchallenged, like the mortgage interest deduction, the municipal bond interest exemption, and the employer-provided health care exclusion. Closing these loopholes would not only provide the means to pay for rate reductions, but would simultaneously remove costly distortions from their respective markets.
The items listed above are not just revenue raisers but good policy changes in their own right. The mortgage interest deduction tilts the playing field toward housing, inducing over-investment that contributes to bubbles. The municipal bond interest exemption encourages state and local governments to take on debt and diverts capital away from private uses. And the healthcare exclusion is arguably the worst loophole in the tax code, as its distortions reverberate throughout the healthcare industry and explain much of its overall dysfunction.
This is not to suggest that these changes would be easy. All of these bad policies continue to exist either because they have entrenched interests which fight hard to keep their benefits or they are politically popular, or both. But if ever there is a time to address these issues it is now, as part of a pro-growth tax reform where large rate cuts can mitigate the impact on those particular groups. At the very least, Republicans should try.
Why not start the move to tax reform from the strongest position on principle and then compromise only as much as necessary to get the job done, rather than starting with what amounts to a pre-emptive surrender in the fight to limit government?