March 5, 2017

Gary Cohn,  President Trump’s Chief Economic Advisor, says that the Border Adjustment Tax (BAT) is off the table. This is a key revenue raiser, a hidden tax, in the Republican scheme to lower corporate taxes. We will continue to hear about BAT as the fight over tax reform heats up. What is it and how will it affect American families?

First, a bit of context. Most other developed countries have a VAT, or Value Added Tax, on purchased goods and services. In the EU most VAT taxes range from 20-25%. In America, we have state and local sales taxes that might add as much as 8 – 10% to the cost of a good. A VAT is like a Federal sales tax of 20%.

Unlike a VAT tax that affects most goods and services, the BAT will affect only imported goods. Here’s an example of the BAT tax using Big-Box as an example of a large merchandiser similar to Wal-Mart.

Big-Box imports a DVD Player for \$80 (Cost of Goods Sold) and sells it for \$100, making \$20 gross profit. It has \$5 other costs which are deducted from gross profit to reach a taxable profit of \$15. Let’s say that Big-Box’s effective Federal tax rate is 30% (27.1% per Congressional Research Service). \$15 taxable profit x 30% = \$5 (rounded) Federal Tax.  Big-Box has a net after-tax profit of \$10, or 10% of the retail price.  Remember that.  Current law = 10%.

Under the BAT proposal, Big-Box could not deduct the \$80 it paid for the good because it is an import. Big-Box’s gross profit is now \$100. Subtracting the \$5 other costs, the taxable profit is \$95. Multiply that by a lower 20% corporate tax rate and the Federal tax is now  about \$19, far more than the \$5 using the current tax system. Big-Box paid \$80 cost + \$19 in tax = \$99, leaving them a gain of \$1, or 1%.  Current law = 10% profit.  Proposed law = 1% profit.

For Big-Box to make the \$10 after-tax profit it has under the current tax system, it would  need to raise the price of the DVD player about \$15.  After paying a 20% tax (\$3) on the additional revenue, it will net an additional \$12. So the customer now pays \$115 for a DVD player that used to be \$100.  No change in quality.  Just an extra \$15 out of the consumer’s pocket for an imported CD player.

What if Big-Box buys the DVD player from an American supplier for \$100?  Under BAT, the \$100 direct cost of the DVD player would be deducted from the sale amount, giving Big-Box a tax CREDIT of \$20 (\$20%).  The after-tax cost of the player is now \$80 direct and the same \$5 indirect cost = \$85. To make a \$12 net profit as under the current system, Big-Box could sell the DVD player for \$97 and undercut another vendor selling the same DVD player for \$115.

In theory, customers would rush to the vendor selling American DVD players. BUT, there is only one DVD manufacturer in the U.S. (Ayre Acoustics) and we don’t know how many parts of their product are imported.  The transition could take years and consumers will pay more for many household goods during that time.

Some products can only be imported.  Most of the lumber used to build homes is imported from Canada.  This hidden tax will be added onto the prices of homes and remodels.  Most diamonds are imported and will bear this hidden tax.  Businesses will lobby to have their product excluded where there is no alternative to an import.  This will be a boon for lobbying firms.

Businesses, particularly durable goods manufacturers, anticipate a complexity in this new tax. Planes, cars, boats, sporting goods and appliances are made with parts from a variety of countries, including the United States. Assessing the component value of imports and exports may require a judgment call by the company, and that is subject to dispute with the IRS. This is sure to become a headache.

Should the BAT become law, customers who have benefitted from the lower prices of imported goods are sure to complain loudly at the higher prices. Retailers have opposed the scheme. Republicans are promising tax cuts for middle class households but the tax reduction won’t offset the extra cost of many household goods.

Republicans have long resisted tax increases in their effort to shrink the size of the government yoke on American families. Many have signed a pledge not to raise taxes. To avoid any appearance of raising taxes, Republican lawmakers had to hide the tax and this was the best they could do.

Side Note: Why not just add the extra \$20 as an import tax, or duty? Import taxes are paid to the government by the importing company of record when the goods are received in the country. Even if an item sits in a warehouse as inventory, the import duty has been paid, creating a cash flow problem for companies. With both VAT and BAT taxes, the tax is not charged until the good or service is sold.

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IRA Contributions

Did you put off making your IRA contribution for 2016? In May 2011, I compared several “timing” scenarios of investing in an IRA for the years 1993-2009.The choices were making a contribution on:
1) July 1st, the middle of the tax year;
2) January 31st following the tax year;
3) April 15th following the tax year

The 1st option had a 2.5% advantage over the 2nd option because of the longer time frame invested. An even greater advantage was an option not on this list. Contributing an equal amount every month produced a 4% greater gain over the first option.

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Stand up or Sit Down

The Bureau of Labor Statistics published a study  of  the time workers spend standing/walking or sitting. The average worker spends 3/5th of their time standing or walking.

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Education in the 21st Century

“Education technology is like teenage sex: everyone talks about it, nobody really knows how to do it, everyone thinks everyone else is doing it, so everyone claims they are doing it…”

That’s just one quote from this TechCrunch article on the investments needed in K-12 and higher education. The author feels that the appointment of Betsy DeVos as Secretary of Education will break up a coalition of interests that has stymied the adoption of technology in classrooms.

Readers who do not support Ms. DeVos may still find themselves in agreement with the author’s comment that “in both K-12 and higher education, technology remains supplemental to chalk-and-talk practices as old as the hills, and not much more effective from a pedagogical standpoint.”

Those who are sympathetic to teacher’s unions will bristle at this comment: “In K-12, the most promising applications of technology have been found most consistently in private and charter schools — freed from the strictures of teachers unions.”

The author discusses a new “10/90” proposal to give higher education institutions some “skin in the game.” Under an Income Share Agreement (ISA), higher education schools would contribute 10% of the amount of every federal loan. After graduation, students would make loan payments based on a fixed percentage of their income for a fixed number of years, with a clear cap on the total amount paid. The schools would recap their money ONLY if students graduated and would thus be more invested in the future of their students.