Proposed border adjustment tax raises questions about future of cross-border supply-chain

As some leading lawmakers in Washington, D.C., explore potential changes to the federal tax code, one idea in particular — the creation of a border adjustment tax — is likely to get more and more attention from many Midwest-based firms.

From the region’s manufacturing industry to its agricultural sector, U.S. and Canadian companies make many products together, through a cross-border supply chain that relies on the open movement of goods between the two countries. 
As one example of how this binational production works, the authors of a recent Automotive Parts Manufacturers’ Association study tracked the making of a car seat. In that one case, an Ontario-based firm used 95 different suppliers — most of them on the U.S. side of the border — to manufacture the seat. 
All told, U.S. content accounts for 8.5 percent of Canada’s total manufacturing output, according to the Embassy of Canada. Likewise, this supply chain means that many U.S. products have had some work done in Canada on the path to completion (see table).
Caroline Freund, a senior fellow at the Peterson Institute for International Economics, says a border adjustment tax “would immediately disrupt supply chains.” That is because all imports would be taxed (at a rate of 20 percent, under a proposal in the U.S. House), including parts that are brought into the United States from Canada or other countries. As a result, many U.S. manufacturers likely would seek American companies to replace longtime Canadian suppliers.  
Supporters of the border adjustment tax say it would encourage domestic production, investments and job creation (U.S. exports would not be taxed). It also could offset losses in federal revenue from a cut in the corporate income tax — another part of proposed changes in the tax code designed to bring investments back to the United States and to stop the practice of reincorporating companies overseas. 
But not only could the border adjustment tax interrupt the cross-border supply chain, it could trigger retaliation by other countries or even by individual companies.
For example, would that Ontario-based seat manufacturer stop using American suppliers if its finished product is subject to a new U.S. import tax?
Many countries have some form of a border adjustment tax, but they also typically levy a value-added tax, or VAT. The VAT is a consumption tax that increases incrementally as value is added to a product.  
For countries with both a VAT and a border-adjustment tax in place, consumers end up paying similar taxes on domestically produced and imported goods. However, the United States does not have a consumption tax. The result of this tax structure would be higher costs for imported goods.  
The World Trade Organization requires signatory countries to treat imported goods in the same way as those produced domestically.
“Our trading partners could quickly get annoyed and target key U.S. exports with countervailing duties,” Freund notes.
Stateline Midwest: April 20173.08 MB