House GOP Business-Tax Plan Upends U.S. Policy, Bares Corporate Fault Lines

[Richard Rubin| November 24, 2016 |Wall Street Journal]

WASHINGTON—Fault lines inside the corporate world are emerging over a proposed rewrite of the U.S. tax code, pitting importers against exporters.

At the heart of the fight is a Republican plan in Congress that would impose corporate taxes on imports while eliminating them from exports, a move that would upend decades of tax policy.

The proposed shift in effect would curtail existing incentives for U.S. companies to move profits and operations abroad, but it would also pose new challenges for some global businesses. Retailers selling imported products and refiners using imported oil could be hardest hit, while some exporters could see their tax bills vanish.

U.S. president-elect Donald Trump promised nothing less than a restructuring of the rules of global trade—a system that has underpinned growth, but that has also cost America manufacturing jobs. The question is how much of the promised change will become reality. Photo: Getty Images

“You’re going to have the big importers fighting the big exporters,” said Lisa Zarlenga, a former U.S. Treasury official and now a partner at international law firm Steptoe & Johnson LLP.

The proposal is part of House Republicans’ blueprint for overhauling the entire U.S. tax code and has been around since June. While still not legislation, it has gained fresh momentum—and scrutiny from corporations—since the November election sweep gave the GOP the chance to advance its ideas with its newfound one-party control of Congress and the White House.

Lawmakers must now weigh competing business interests to achieve the country’s first major tax revamp since 1986. “Tax reform always hits different industries differently,” said Republican economist Douglas Holtz-Eakin. “It’s the ability to rise above those differences that makes tax reform hard.”

Other crucial elements of the business-tax plan would also be a major departure for the U.S. and include dropping the corporate tax rate to 20% from 35%. Companies would also be able to write off capital expenses immediately but couldn’t deduct net interest.

At present, U.S. corporate taxes are based on where profits are earned, which often isn’t the same as where products are sold. Because the proposed taxes would be based on the location of sales, where a company establishes its formal headquarters would matter less. So the plan could deter the practice of putting a company’s legal address in a low-tax country, a move known as an inversion. Under the plan, the U.S. would also give up any claim on taxing its companies’ foreign sales.

The location of profits wouldn’t matter either, sharply limiting the benefit companies have gained from putting intellectual property in tax havens. Instead, the system might encourage companies to locate manufacturing in the U.S. to export to foreign markets.

“This is a significant break with the past,” Rep. Kevin Brady (R., Texas), chairman of the House Ways and Means Committee, said in an interview. “America, in our blueprint, will no longer stand idly by and watch our jobs, innovation and headquarters be chased overseas because of our uncompetitive tax code.”

The proposal would operate like provisions other countries use to border-adjust their value-added taxes so those levies apply only to domestic consumption. President-electDonald Trump has complained that Mexico’s value-added tax system—a consumption tax at each stage of production that is then removed at the border—advantages its exports to the U.S. 

Unlike separate import tariffs the president-elect has proposed, the tax in the House plan would apply equally to all goods sold in the U.S.

For goods sold in the U.S., the new system would be neutral between U.S. and foreign production because both would be subject to the same 20% corporate tax rate. The change from the status quo, however, wouldn’t be, Mr. Holtz-Eakin said.

The proposed system might create competitive advantages for U.S.-made products. Exports to France, for example, would bear no U.S. tax when the French VAT is applied, while competing products made abroad would bear the French VAT and a non-U. S. corporate income tax.

Other countries could challenge the U.S. system envisioned under the Republican plan at the World Trade Organization. But the U.S. might then argue the system it is close enough to a value-added tax to pass legal muster, while insisting at home that it isn’t a politically toxic VAT. Mr. Brady said he is confident the envisioned tax plan would win any challenge.

Economists say changes to America’s balance of trade would be modest because currencies would adjust. It isn’t exactly clear what would happen to prices. Mr. Brady said he expected global supply chains and currencies to adjust efficiently, and the committee is working on transition rules, though for individual companies and industries, the effects may be pronounced and disruptive.

There already is some resistance in the U.S. to the GOP approach. “While we appreciate that both the president-elect and new Congress want to move forward on comprehensive reform, the problematic tax on imports contained in the House blueprint is cause for concern,” the Retail Industry Leaders Association, whose members include Target Corp.and Whole Foods Market Inc., said. “We will work to highlight its harmful impact on consumers and the industry.”

Retailers, especially those that can’t substitute domestic products for imports, are “very concerned” as they study the plan, said Rachelle Bernstein, vice president and tax counsel at the National Retail Federation.

Border-adjusted taxes would be “extremely harmful to the refining industry,” said an executive at a large oil refiner. Imported products would face the new tax, and domestic refiners would be disadvantaged when domestic oil producers decide whether to sell to firms subject to U.S. taxes here, or in the tax-free export market.

Rep. Jim Renacci (R., Ohio), a Ways and Means member, said he has been hearing from companies already. “When you drive costs up on a refinery, the consumer’s gonna pay for it,” Mr. Renacci said. “I am getting a lot of companies that are very concerned about it.”

Others would benefit, though. Combined with the cut in the corporate tax rate and access to stockpiled foreign earnings, the GOP plan would “level the playing field” for U.S.-based companies, said Bob McGovern, senior vice president of tax at Merck & Co., a major drugmaker that imports and exports. “There seems to be more incentives to be in the U.S. and therefore it’s much more attractive than it would be today,” he said.

Pharmaceuticals, medical devices and consumer products company Johnson & Johnson is optimistic about the House proposal, which would create incentives for U.S. innovation and manufacturing, spokesman Ernie Knewitz said.

And the changes to the tax system could be quite complex for those with global supply chains that import and export components and products, such as auto manufacturers and Apple Inc.

Still, the plan’s path forward is uncertain. While it has support from House Republicans, senators and Mr. Trump haven’t weighed in.