COMMENTARY: BAT's conflicting rationaleA stronger dollar doesn’t mesh with stronger exports, and manufacturers need exports By: Eric Johnson | February 10, 2017Photo: Zimmytws/Shutterstock If the economic reasoning behind the border adjustment tax (BAT) has you a bit perplexed, you’re not alone. The BAT is a piece of a broader plan to reform the U.S. corporate tax code that seeks to completely reorient the U.S. economy toward domestic production of goods. It does so by taxing imported goods at the point of consumption rather than on income earned – essentially, an importer would have to pay taxes on the entire cost of a sale, rather than on its revenue minus input costs. The BAT, proposed in mid-2016 by a group of Congressional Republicans and given renewed impetus when President Donald Trump swept into office in November, has been a hugely controversial concept in the early weeks of the new administration. The Adam Smith Project talked to economists and tax experts to get a better sense of the secondary and tertiary impacts of such a tax, but one thing remains clear: people can’t predict what the impacts will be yet, because so few details have emerged. Leaving aside the question of who is in favor of the idea (largely U.S.-based manufacturers who would gain from being exempt from paying taxes on exports) and those against the idea (largely retail importers who have spent decades building global supply chains), let’s look at two key consequences of the BAT that haven’t been well understood or explored to this point. The first is a fundamental conflict between what the Trump administration has declared as its key economic issue (growing U.S. manufacturing jobs) and a critical premise of the authors of the BAT proposal. BAT proponents believe strongly that the implementation of such a tax would induce the dollar to strengthen significantly. That stronger dollar, they argue, would offset some of the hit that importers would take through paying higher taxes on sales of imported goods because their dollar would be more valuable and thus allow them to buy more goods. So let’s assume, for a second, that they are correct. Assuming the dollar becomes stronger, how does that jibe with the administration’s stated intent to grow the U.S. manufacturing sector? If the BAT causes the dollar to increase in value, and if exports are, by definition, hurt by a rising dollar, will there be enough demand in the U.S. alone for all the manufacturing growth the current administration and Congress are trying to drive? Aren’t those conflicting targets? While the United States has become the global poster child for a consumption-based economy, the reality is that the U.S. consumer population is an aging one, and that 95 percent of all consumers live outside the United States. Simply put, if the U.S. manufacturing sector is to grow significantly enough to become a driver of jobs, a sizable percentage of that sector’s output has to be tied to exports. But in a scenario where the dollar is stronger than today, that hurts the ability for manufacturers to compete on the global market. Most U.S. exports already face non-tariff, protectionist barriers in foreign markets that are hard to overcome. A self-imposed barrier would make it that much harder. BAT proponents might rightly point to the fact that exports would be exempt from taxation, thus allowing U.S. manufacturers to price their goods more aggressively. But, as the National Retail Federation noted in a commentary for the Adam Smith Project, counting on currency policy to change as you want it to is no sure thing. It’s just too hard to know whether that tax benefit would wholly or partially offset the impact of a stronger dollar. If the dollar doesn’t strengthen, exporters would benefit, but retailers would be hit especially hard. But let’s get back to the scenario where the dollar strengthens. If that were to happen, manufacturers would find their avenues to export blocked and would have to sell almost exclusively to U.S. buyers. Maybe that’s a dream scenario for those looking to stoke “Made in America” initiatives, but it also would significantly inhibit pricing leverage for U.S. suppliers. If retailers know that those U.S. suppliers can’t compete in foreign markets, they can drive down prices for U.S. made goods. In which case the pro-manufacturing tax rebounds on the companies it’s intended to help, and the return of the U.S. manufacturing sector looks more like a shift to making low-cost goods for companies duty-bound to buy from specific suppliers. Let me be clear: I don’t think that scenario is likely. As Vox’s political reporter Matthew Yglesias recently put it in an article arguing the BAT isn’t certain to raise the value of the dollar: “For the world’s largest economy to undertake a tax reform on the scale House Republicans are contemplating entails a 25 percent increase in the value of the U.S. dollar. That’s simply much too big a change for world governments to watch from the sidelines.” But, again, let’s leave aside whether the dollar would appreciate under a BAT scenario. Let’s just look at the reasoning behind assuming that it would. A strong dollar has a lot of benefits for the U.S. economy. As economist and Adam Smith Project contributor Walter Kemmsies put it, a strong dollar is a sign of a country with a strong economy and rising interest rates. But a strong dollar is inarguably bad for exporters, even if their tax bills go down. And there’s no getting around the conflicting theses of the BAT’s authors and the drive to build up the U.S. manufacturing base. Now, on to a second conundrum: just how a BAT would apply to the utterly complex supply chains behind most goods consumed in the United States. A U.S. import isn’t just an import full stop. For instance, Kemmsies said for every dollar of goods imported from Mexico, 40 cents originally came from the United States. The North American Free Trade Agreement has created a seamless continental supply chain platform, where raw materials, semi-finished goods, manufacturing and final assembly can flow unimpeded across borders. That flow is much more unidirectional from Asia, because there are no free trade agreements between the United States and its biggest trading partners there, and also due to distance. But it’s still not a binary situation. Supply chains are global by nature, and the United States is not the only consumption market. So if a global multinational company wants to sell in Europe and North America, it’s likely best served sourcing in Asia, at the midpoint between those two markets. A BAT not only fails to take into account that companies have set up their supply chains for specific reasons, it’s asking those global companies to favor one market over another. This all comes down to how a BAT would be enforced with regard to rules of origin. Would the BAT specify that a certain percentage of components of a good be made in the United States? What would that percentage be? What about the bill of materials for those components? And what would that percentage be? Or would it suffice for the product to be merely assembled in the United States? So much is unclear, and that’s what is making it so difficult for companies likely to be affected. Changes to supply chains take time. Development of manufacturing capabilities takes time. If the BAT is going to be implemented, the global trade community needs to know the answers to these specific questions as quickly as possible. Theoretical economic models don’t really help chief supply chain strategists that need to figure out if they need to move factories back to the Unites States or cultivate a new ecosystem of U.S. suppliers. If there’s an underlying unease from importers around the BAT, it comes from two places: a lack of details, and conflicting priorities. It’s up to proponents of a BAT to clarify both those issues.