Border Tax Adjustment To Pull Down Retail Margins Further

As US lawmakers are set to implement one of the broadest tax reforms, one proposal that has the potential to cause an upheaval is the tax aimed at import-dependent companies. As per the House of Representatives proposal, taxing imported goods “will eliminate the incentives created by our tax system to move or locate operations outside the US.” While the proposal is not an import tariff, the ‘border tax adjustment’ prevents companies from writing off their import costs on their taxable income, effectively raising their tax bills. President-elect Donald Trump has called for protective tariffs in the past, so there is a high chance he will be on board.

The border tax adjustment will affect US companies importing everything from oil products and machine parts, to smartphones and food and beverage items. This will inadvertently force such companies to raise their prices, accept pressured margins, or revamp their supply chains. The companies set to have the biggest impact are the clothing and shoe companies, which are most dependent on imports, with 98% of clothes sold in the US made overseas. Companies such as Wal-Mart (NYSE:WMT), Gap Inc. (NYSE:GPS), Coach (NYSE:COH), Ralph Lauren (NYSE:RL), and Nike (NYSE:NKE), would see a hike in their import costs, since most of their merchandise is imported. Stephen Lamar, executive vice president of the American Apparel and Footwear Association, reiterated this fact, and predicts an “outsized adverse impact” on the apparel and footwear industry, which is reliant on global supply chains to provide the American consumers products they desire. According to the National Retail Federation trade group, the import tax could raise the tax bills of some apparel chains by three to five times their pre-tax profits, jeopardizing their solvency. While there is no clear cut answer on how it would impact the price of the goods, it will definitely result in a rise in the costs of the companies, and adversely affect the already pressured margins.

The House plan provides a template for tax legislations which will take place next year, which has also dampened the post-election optimism, which was founded on the Republicans vowing to cut the corporate tax rate from 35% to 15% or 20%. The reasoning behind this is also to limit the imports into the country, and spur the exports, in order to reduce the burgeoning trade deficit. This border tax adjustment would work by eliminating US companies’ current ability to deduct their import costs from their taxable income, meaning that they would be taxed on the full value of the sale, rather than just the profit. Meanwhile, export revenues would be excluded from tax bases, giving them an advantage in the proposed change. While raising taxes on products does result in a reduction in sales, as has been the case with tobacco products, the resultant effect in this case is not clear. According to economists, such adjustments may not have the desired impact because at the end of the day, currencies and trade flows adapt to the changes in taxation. For example, if US exporters’ costs are reduced, due to the reduced taxes, and are able to export their goods at a lower value, it would result in an increased demand for them, causing the US dollar to rise, leading to higher overseas prices, and ultimately moderating the overseas sales of the products.

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