US: The Politics of the BAT

Published on January 20, 2017

Key Takeaways

 

  • Despite President Trump’s apparent reluctance earlier this week to support the border adjustment tax proposed by the Capitol Hill Republican leadership, we still expect a modified BAT will be unveiled in the next few weeks.

 

  • The BAT will face formidable political and lobbying opposition, and we put its chances of passing in the House, as is, at no more than 30%, perhaps even less in the Senate. Additional exemptions and extended transition periods would, however, lift those probabilities considerably.

 

  • But changes to the bill could substantially lower its revenue gains to offset the cost of the corporate tax cuts, and the shortfall would have to be closed to ensure budget neutrality and that it moves under budget reconciliation rules to protect against Senate filibuster.

 

  • The revenue shortfall would need to be covered either by raising the new corporate tax rate from its target 20% or by drawing on the funding for a major infrastructure program. In the meantime, some in the White House are holding out for simpler trade tariffs.

January 20, 2016

Some time relatively soon, perhaps within weeks, of Donald Trump’s inauguration as the 45th President of the United States today, one of the earliest, defining tests of the Trump White House and the Capitol Hill Republican leadership will be the outcome of the internal debate over the proposed border adjustment tax.

Here is what we believe to be the current state of play:

Despite the intervention by President-elect Trump and apparent disdain for the BAT as “too complicated” in an interview with the Wall Street Journal earlier this week, it is our understanding that House Speaker Paul Ryan and House Ways and Means Committee Chairman Kevin Brady will press ahead and unveil a draft BAT legislation perhaps within a few weeks.

Administration officials have since walked the Trump criticism back, spinning it as a complaint about its marketing, not the merits of the proposal itself. Both White House and Hill Republican sources have also made a point of stressing how extensive their discussions have been in recent weeks. “We are in complete sync,” Ryan insisted.

But Trump’s initial hesitation to fully embrace the BAT may also reflect a more finely tuned political ear, in that the BAT faces formidable opposition. The BAT proposal is easily the most contentious and controversial piece of the proposed corporate tax reform, due to its far reaching consequences for large segments of the US economy and unforseeable effects on exchange rates, trade flows, and global supply chains.

It will face fierce opposition from powerful lobbying by the oil and gas, retail, and automobile sectors, among others. And it will draw few if any Democratic votes, which means it must pass entirely on a partisan Republican majority vote, but many Republicans, perhaps dozens, are not fully on board.

Indeed, without further modifications to neutralize the lobbying against the bill and to keep Republican votes in line with the leadership, we would put the odds on a BAT passage on Capitol Hill at no more than 30%. And while additional exemptions or extended transition periods would lift those probabilities considerably — especially with strong leadership from President Trump — it also means a crucial revenue offset to cover the overall costs of corporate tax reform revenue offset will either decline or disappear.

The lost revenues, in turn, would have to be found elsewhere, either by raising the new corporate tax rate from its targeted 20% to 25% or even 30%, or by tapping the expected capital repatriation tax revenue gains, which would strip funding away from the planned infrastructure program, a key campaign plank of the self-described “infrastructure” president.

It should also be noted that there remains a lingering support within the Trump White House for straightforward tariffs — or at least, as Commerce Secretary Wilbur Ross laid out in his confirmation hearings, the threat of tariffs as a negotiating tact for revisions to existing trade treaties — as an alternative means to work towards President Trump’s trade agenda. A unpredictable swing away in Trump’s support for the BAt cannot be entirely ruled out.

BAT a Linchpin to Corporate Tax Reform

The BAT is a linchpin to Ryan and Brady’s ambitious corporate tax reform that will replace the current territorial-based 35% tax rate with a 20% “destination-based cash-flow tax” system. The broad tax reform plan — the DBCFT in Hill staff memos — is more or less a value-added tax similar to that of most European countries, but importantly include a tax deduction for wages. It will include limitations on interest expense deductions to favor equity over debt, and of great interest to the markets, propose special rates for repatriating offshore earnings.

The BAT piece of the tax reform would tax all imports at 20% and remove all deductions for the cost of imports, and exclude all exports from taxes in the form of rebate. It has been pitched as a counter to China’s trade policies, the means to ending tax inversions, promoting the US manufacturing sector and bringing jobs back home – a key plank of the Trump campaign. Ryan has been describing it as key to a “built-for-growth tax code” and even as “responsible nationalism.”

But its main attraction and importance to the Ryan/Brady corporate tax reform is a credible Tax Policy Center estimate that it could bring in as much as $1.3 trillion in tax revenues over ten years. That makes it absolutely crucial to offsetting the estimated $1.8 trillion costs in the cuts to the corporate tax rate from 35% to 20%.

That is especially important because the tax reform legislation must be scored by the CBO as revenue neutral — i.e. not adding to the deficit — over a ten year baseline. Without that, ┬áthe entire tax reform package loses the protection against Senate filibuster under budget reconciliation rules, which would only require a simple 51-majority vote in the Senate.

Staying within budget reconciliation will be vital if the BAT and corporate tax reform has any serious chances to pass later this year. Democrats will largely unite in both the Senate and House in opposition, highlighting the legislation as a a regressive consumer tax, especially for the poor, with high prices being passed on to consumers (gasoline prices are estimated to jump by 30 cents a gallon) while offering big tax rebates to big exporters, which would fit uncomfortably with the populist rhetoric that got Trump elected.

And while much of the BAT’s political difficulty is presumed to be in the Senate and the Senate Finance Committee, we suspect the most fierce pressure will in fact come in the House, most likely in the procedural vote on the House floor.

What’s more, not all Republicans are on board, worrying about a backlash in their home districts and states, and will have to be won over or whipped to stay in line. Our sense is that there are several dozen mainstream Republicans uncomfortable with the impact the tax will have on jobs in their districts and the damage to the retail sector in particular.

While some Republicans have major exporters in their districts, all of them have a Walmart and other retail outlets in their districts, which stand to lose. And all of them belong to the powerful National Retail Association, which is lobbying hard against the BAT.

Fierce Anti-BAT Lobbying Expected

The pubic lobbying against the BAT is relatively muted for now, if only because the groups most negatively affected are keeping their lobbying behind close doors, seeking exemptions or long transition periods for their respective industries or sectors.

Nevertheless, it is our understanding a formidable lobbying effort is being planned, led by oil and gas interests, and especially the retail sector and their representative associations, the National Retail Association, the American Apparel and Footwear Association, and the Retail Industry Leaders Association, representing the likes of Walmart, Home Depot, Target, and smaller retailers dependent on imports of clothing — 98 per cent of clothes sold in the US made overseas — computers, furniture, and automobiles. The line of attack will be based on the inevitable jump in the consumer costs, such as gasoline, which by some estimates, would rise by 30 cents a gallon.

There is no small amount of frustration among the House Republican leadership, pressing for patience before the political battlelines are drawn. They note there are all sorts of modifications to the bill before it goes to a vote in the WMC. There is talk of exemptions or extended transitions for raw materials and certain commodities like crude oil, or for the time retailers must adapt to the import tax. What’s more, the political assessment of the BAT cannot be taken without putting it within the context of the broader tax changes, the lower rates, repatriation effects, full expensing, and the like.

But for every exemption or transition extension granted in the final version of the BAT legislation, it will reduce the next revenue gain that is the main political appeal of the BAT. The lost revenue will have to be found elsewhere, either raising the target 20% corporate tax rate from 20% to 25% or even 30%, or perhaps by reaching over into individual tax reform by putting limits on mortgage-interest deductions, deductions for charitable contributions, or state tax deductions, which would only ensure a full Democratic opposition since they represent the high tax states on the East and West coasts.

Otherwise, alternative sources of revenues would have to be found to keep the tax reforms budget neutral, but that too could have a collateral political costs. For instance, the GOP Hill leadership could tap all of the projected tax revenue gains from the capital repatriation tax break legislation being considered. But that in turn would leave little for the proposed infrastructure spending that was set to draw a large chunk of its funding from the cap repat revenues.

Indeed, the scramble to fund the overall tax reform package may be one reason why the Hill GOP leadership has pushed the infrastructure program to the summer, which means it could fall by the wayside relative to higher priority among Capitol Hill Republicans for tax cuts compared to a major infrastructure program that is a priority for the incoming President.

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