If the U.S. economy is ever going to regain its past economic mojo, then Congress must pass comprehensive tax reform. Consider how much has changed since the last major tax reform in 1986.
Back then, Bill Clinton was the governor of Arkansas, Mike Tyson had just become the youngest heavyweight boxing champion of the world and the cutting-edge Apple computer was the IIGS. Dramatic changes to the economy have also occurred.
America’s economy today is more complex and more connected to the global economy than back in 1986. Supply chains span multiple countries, investment flows more freely across international borders and the comparative advantage of U.S. workers has changed dramatically.
Throughout all these changes, the U.S. tax system has remained stagnant, harming U.S. competitiveness. Meanwhile, other countries have improved their tax systems. Reigniting economic growth in the United States, consequently, requires significant improvements to our tax system.
But how taxes are reformed is crucial. Poorly-structured tax changes could create economic disincentives and increase costs that would ultimately hurt economic opportunity in our nation.
In the House Republicans tax-reform proposal, “A Better Way,” a new border-adjustment tax, or BAT, is included to ensure budget neutrality. If implemented, the BAT would tax imports, but exempt exports. Due to the large U.S. trade deficit, this tax change raises significant amounts of revenue for the government — current estimates claim the BAT would generate $1 trillion in revenue over the next decade. The BAT, therefore, eases the goal of making tax reform revenue neutral.
There are unintended consequences from the BAT, however. As noted above, the goods and services individual Americans purchase are increasingly produced with complex supply chains that are part of the interconnected global economy. American consumers benefit greatly from receiving higher-quality goods and services at lower costs.
The BAT would tax all imports, including components and other services used by domestic companies to produce goods and services. Taxing these imported inputs will increase the costs of domestically produced goods and services — and may make them unaffordable for many Americans.
As one example of this impact, a BAT will increase the insurance premiums paid by all Americans. According to a new joint study from the R Street Institute and Pacific Research Institute (PRI)that focused on the impact from a BAT on California, Californians alone could see insurance costs rise $1.91 billion over the next decade if Congress enacts a BAT.
Just how would this proposed tax increase insurance rates?
Insurance is all about managing risk. One way insurers mitigate their risks, and therefore offer more affordable insurance policies, is by purchasing reinsurance (insurance for insurers), often through international firms. Right now, insurers don’t pay taxes on these costs, as with any other cost of doing business.
A border-adjustment tax removes this equal treatment, levying a tax on imported costs. As a result, more risk will be held in the United States and our insurance markets will become less competitive and more costly. As the R Street/PRI study found, the BAT will cause Californians to have higher insurance costs, and worse insurance coverage.
These unintended impacts are not unique to the insurance market either. The growing complexity of the global economy nearly guarantees that a complicated tax system such as a BAT will impose unnecessary disruptions and costs on other sectors of the U.S. economy as well.
It is important that policymakers fully appreciate the impact of their proposals before rushing to act. The right way to reform our federal tax system is not by embracing complex proposals like the border-adjustment tax that may have serious unintended consequences.
If we are truly serious about federal tax reform, then Congress and the White House should consider scrapping the federal tax code altogether and implement a simple flat tax. A flat tax would junk the complexities of the Internal Revenue Service and its massive tax bureaucracy and instead put in place a clear and easy-to-understand tax system.
In order to reinvigorate economic growth, the goal of tax reform should be to implement a simple tax system that reduces the cost of tax compliance and the cost of the tax-collection bureaucracy. Passing a complicated tax scheme that raises the costs of many economic goods, including insurance premiums, is the wrong approach.
(Note: Opinions expressed in this report are Powell’s and do not represent those of the University of Alabama.)