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September 7, 2006

There’s Help at the Border

Duties on imports and rebates on exports could go far to help domestic manufacturers.

When Revere Copper Products Inc. considered an acquisition in Great Britain three years ago, President Brian O’Shaughnessy was surprised that the target company bore such a small tax burden.

The reason, O’Shaughnessy realized, was that the British government uses a border tax system that levies value-added taxes (VAT) on imports but rebates that amount on exports. This compensates exporters for the tax they will have to pay in the importing country. The system favors domestic manufacturers by raising the price of competing products from abroad while reducing the price of British exports.

Britain is among 29 members of the Organisation for Economic Cooperation and Development (OECD) that use border tax reconciliations to help protect their domestic manufacturers. The United States is the only OECD member that does not.

A small but growing number of U.S. manufacturers, economists and lawmakers now suggest that a similar tax system adopted here could go far to protect manufacturers buffeted by cheap imports.

The debate still is preliminary. A border tax system would entail a sweeping overhaul of the U.S. tax code—no small task—and stiff opposition from big importers such as Wal-Mart Stores Inc.

REVERE’S RIDE

Revere—a Rome, New York-based maker of rolled and extruded copper and brass products founded in 1801 by legendary American silversmith and patriot Paul Revere—did not acquire the British company. Instead, O’Shaughnessy came home with a lesson about the international tax system and an idea for protecting American jobs. Every time an import arrives in Britain, the government slaps a 17.5% VAT on the product (there are discounted rates for basic necessities and foods), paid by the importing company. When a British company exports a product, it enjoys a 17.5% government rebate on the declared value.

“The realization now for me is that it’s a much more significant issue than I ever thought,” O’Shaughnessy says. “I don’t think manufacturing jobs and service jobs in the United States can survive without a change in the tax structure to a VAT-type system.”

O’Shaughnessy and others are trying to mobilize grassroots support while lobbying in Washington. The issue is on the agenda at Nucor Corp.’s well-attended town hall meetings. Revere and five other local manufacturers plan a September event in New York.

“There is a crisis in manufacturing,” says David Hartman, an economist and retired banker who chairs the Lone Star Foundation, a conservative research and advocacy group based in Austin, Texas. “Is it because we’re no longer innovative, productive, economically advanced? The answer is no. The problem is how we are taxed.”

Hartman, the former chairman and CEO of Austin-based Hartland Bank N.A., which he sold in 1999, has written extensively about how the United States must adopt border taxes to save its manufacturing sector. His foundation backed a lobbying campaign in Washington and has organized meetings to promote the issue. “Not only are we giving foreign competitors an 18-cents-on-the-dollar advantage in our home market, we’re getting an 18-cent disadvantage in their market,” Hartman adds, referring to the 18% average border tax among the other 29 OECD countries.

Broadly speaking, advocates propose that the United States slash its corporate income tax, and perhaps the personal income tax as well, institute a consumption tax that could be shaped as a simplified version of Europe’s red tape-heavy VAT system and adopt a border tax close to the 18% OECD average.

GETTING KILLED

It is impossible to adopt a border tax on imports and exports, and leave the income tax system as is. The World Trade Organization (WTO) does not allow it. Under WTO’s rules, the border tax rate cannot be higher than the tax rate on domestic consumption. Hence, for the United States to adopt the border tax, it also must create a domestic consumption tax.

Few elected officials would want to add such a huge burden on U.S. taxpayers, of course. The only way to make it politically feasible is to create a package that is revenue-neutral for the federal government. That can be done only by cutting corporate and personal income taxes.

The U.S. government has tried other ways over the years. Since the 1960s, it has adopted various tax incentives for exports, but all versions have been ruled in violation of the General Agreement of Tariffs and Trade and its successor organization, the WTO, because they were viewed as export rebates.

Bob Johns, director of marketing for Nucor Corp.’s Sheet Mills Group, who also leads trade-related programs for the Charlotte, North Carolina, steelmaker, says it’s unlikely the WTO will reverse its rulings against U.S. export-related tax incentives, or that other countries will eliminate their border tax systems. Therefore, he says, adoption of a consumption and border tax is “probably the most practical and doable” choice for leveling the international playing field globally speaking, although it’s a political third rail for U.S. legislators.

“The status quo is totally unacceptable,” he says. “Anybody in trade-sensitive industries [in the United States] is getting killed by this. Our inaction on the matter absolutely defies logic to those of us in manufacturing, because it’s such a large issue. It’s right up there with currency manipulation.” Inaction may be frustrating, but action will require a comprehensive overhaul of the tax code. And the likelihood of that happening in an election year is remote.

A few tax bills toy with the idea. For example, Rep. Phil English (R-Pennsylvania) in February introduced the Simplified USA Tax Act of 2006, H.R. 4707, which would apply a border tax rate of 12% on imported inventory, goods and services, but not tax sales of U.S. exported goods and services. The bill is pending in committee, where it’s likely to languish until the end of the session.

Rep. Paul Ryan (R-Wisconsin), a rising star on the tax-writing House Ways & Means Committee, says a border tax would go far to help manufacturers. Ryan would like to see the corporate income tax eliminated as part of tax reform, although he acknowledges that detailed planning of an alternate structure is needed.

“I think we’ve got to keep an open mind about how we replace the tax system with one that is fairer, simpler and more globally competitive. Whichever way you go, I think border adjustability has to be a key component of that,” Ryan says. “We could end the bias against manufacturing in the United States.” He is considering introducing a reform bill next year and predicts that the prospects for congressional action will grow in the next few years.

Gary Clyde Hufbauer, a senior fellow at the Institute for International Economics in Washington, D.C., says only a weak economy will persuade Congress to take such far-reaching action as adopting the border tax. But times will get tougher, he predicts. Already huge federal budget deficits will worsen because of the cost of war and entitlements such as Social Security and Medicare, and continuous trade deficits will lead to higher interest rates and a shaky stock market.

“I think for sure the next president, if not this president, will face those tough times, and I think that will galvanize the Congress,” Hufbauer predicts.

FORMIDABLE OPPOSITION

Regardless of how hard times may become, a border tax will draw fierce opposition from big retailers and other importers. “Who likes it the way it is? Wal-Mart,” Hufbauer says. Most big retailers tend to rely heavily on cheap imports from China and other low-cost countries, and a border tax would kick up the price of their goods.

Last November, an advisory panel to President George W. Bush on federal tax reform issued a report that evaluated alternate suggestions for tax reform. One scenario included a modified VAT and border tax reconciliations that would increase import prices by as much as 30%.

“A very large percentage of what we see in retail stores is imported, and that would greatly increase the price of goods and reduce business,” says Rachelle Bernstein, tax counsel at the National Retail Federation (NRF) in Washington, D.C.

The NRF has lobbied against the idea of a border tax and would step up those efforts if the issue started to get traction in the Congress, Bernstein says. If the border tax is to stand any real chance in the next few years, it will need the backing of the biggest voice for American producers, the National Association of Manufacturers (NAM). Without NAM’s undivided support, the opposition from retailers and others likely would be too much to overcome.

NAM has yet to take an official position and has sent mixed signals on the subject. NAM President John Engler in February wrote a letter to then-Secretary of Treasury John Snow, expressing concern about the advisory panel’s proposals and noted that a border tax could, for example, increase the price of imported oil by 30%. “Because manufacturers depend heavily on oil for heat, transportation and, in some cases, as a feedstock, this increase alone would have a huge negative impact on the manufacturing sector,” Engler wrote.

“Some of the aspects of the border adjustable tax do concern us,” says Dorothy Coleman, NAM’s vice president for tax and domestic economic policy. “While the NAM thinks that our current tax code is a drag on economic growth and we need a more pro-savings, pro-investment tax code, we haven’t decided on what approach is best.”

But the NAM position could evolve. “We need to look at everything that’s creating a comparative disadvantage for making things in the United States,” says Fred Nichols, NAM’s former chief lobbyist who moved to the Department of Homeland Security in April. “The border adjustable tax is clearly one alternative that favors manufacturing in America.”

That’s encouraging to O’Shaughnessy, who says he’s “working hard to make this an issue” in the November elections, “so that following the election, there will be a message and a mandate to move forward on this kind of a tax. Politicians are going to be forced to take sides.”