The Border Adjustment Tax

Consider the transcontinental railroads of the late 1800s. The Hoover Dam of the early 1900s. And the moon landings of the late 1900s. America’s federal government has compiled a strong historical record for producing impressive feats of engineering innovation, hasn’t it?

More recently, though, government leaders in Washington DC appear to be more interested in constructing innovative methods of taxation. One such example is the border adjustment tax.

What exactly is a border adjustment tax? Many business news organizations are referring to it as a “complex” mechanism, but it isn’t very complicated in nature. Domestic American manufacturers that sell products within the United States would pay relatively low taxes on their profits. Foreign firms that sell to Americans, however, would pay relatively high taxes.

Meanwhile, domestic American manufacturers that sell products overseas would pay relatively low taxes in the United States. They’d be liable to pay taxes in those overseas jurisdictions, though.

Is this truly a tax innovation? Well, the name “border adjustment tax” is indeed a new moniker. But the mechanism is actually an age-old one. In essence, imported goods would be subjected to import taxes. And exported goods would be granted tax breaks.

That policy is called protectionism; it was first introduced in the United States two centuries ago with the Tariff Act of 1816. Its goal is to utilize tax policy to support domestic manufacturers by driving up the cost of imported goods.

That sounds fairly simple, doesn’t it? Then why don’t all nations practice it? Actually, all do to some extent, but the policy fell out of favor during the Great Depression of the 1930s.

Why? Because the Depression was immensely worsened by the imposition of the Tariff Act of 1930 in the United States. Known colloquially as the Smoot Hawley Tariff after its congressional sponsors, the protectionist tax triggered reprisal laws in many of the world’s leading trade nations.

The result, in retrospect, wasn’t difficult to foresee. When each of the nations within a trading group suddenly decides to make the products of other nations far more expensive for its own citizens, global trade grinds to a halt. Factories close, employees become permanently unemployed, and markets crash.

That’s a grim scenario, isn’t it? Although the Great Depression occurred more than eighty years ago, it would be helpful to remember its economic lesson today.

So the next time a government leader refers to the Border Adjustment Tax as an innovation that can support domestic manufacturers and bolster the national economy, you might want to think about Smoot and Hawley.

And perhaps you’ll also remember that today’s Border Adjustment Tax isn’t really an innovation at all. It might offer some support for domestic manufacturers in the short term, but when foreign governments retaliate in kind, it might again cause the national economies of the world to come tumbling down in the long term.