In recent news, there have been discussions on Capitol Hill about potential legislation introducing a border adjustment tax. Such a tax could disrupt global supply chains and consumer demand, increasing uncertainty in investment markets in the near term. While our U.S. Value Equity Team is modeling which sectors may be the most impacted, there are still a lot of unknowns about how the tax will be implemented. Until there is more clarity, we are taking a wait-and-see approach.
What Is a Border Adjustment Tax?
Similar to a value-added tax, a border adjustment tax (BAT) specifically targets imported goods. Very simply stated, a BAT taxes imported goods and exempts exported goods from a company’s tax base, effectively creating an export tax subsidy.
A BAT is calculated based on the destination of goods, rather than their origin. For example, if a corporation manufactures goods entirely in the U.S. and sells them to another country, the profit the company makes is not taxed. However, if an American company imports supplies or parts to make goods in the U.S., the profit it makes on those goods is taxed. Additionally, the company cannot take a business expense deduction for foreign parts.
Arguments for and Against the Tax
|Proponents say a BAT will:
|Opponents say a BAT will:
Potential Impacts to U.S. Companies
Wall Street analysts are still trying to understand how the BAT might specifically affect companies that rely on imports, but because there’s so much up in the air, there is no consensus. The impact will be significant: Companies relying on imports could see higher taxes and potentially lower net income.
We don’t believe it’s likely the BAT will accomplish its advertised purpose. Instead we only see it being effective in its ability to offset the tax revenue that would be lost in the proposed corporate tax cuts. However, using a BAT to accomplish tax reform seems like a dangerous game, especially given the risk of sparking a trade war and the extremely disruptive effects it will have on global supply chains and consumer demand.
While companies with exclusively U.S. pre-tax income and no imports would seem to be the clear winners, business practices or qualities that can help a company mitigate the BAT impact include:
- Importing through vendors, as opposed to direct sourcing, whom they can force to share the tax burden.
- Major scale in importing operations, which will allow for larger and faster foreign currency transactions.
- High gross margins, which indicates that the cost of imports are a small portion of total costs, making the added tax easier to manage.
- Pricing power, high-income customers, and/or non-discretionary product mix that allow them to full pass the added costs to consumers through higher prices without significantly impacting the demand for the goods.
While the probability that a BAT is included in tax reform has been increasing, Corporate America is generally split on the issue. We still see a wide range of outcomes in BAT inclusion and implementation, especially given the lobbying battle brewing in Washington. As such, we are modeling the impact to companies we cover, but waiting to take investment action until the course becomes more clear.
The opinions expressed are those of Matt Oldroyd, CFA, CAIA, and are no guarantee of the future performance of any American Century Investments portfolio. For educational use only. This information is not intended to serve as investment advice.