Most retail companies pay at or close to the current 35% tax rate and benefit from few of the tax breaks that lower the tax bills in other industries. Without question, the retail industry would benefit from comprehensive tax reform that would broaden the tax base and lower corporate tax rates. However, the foreboding dark cloud of the Border Adjustment Tax (BAT) that is part of the comprehensive tax reform plan will slap an estimated 20% border tax on imported goods that will effectively eliminate tax deductions from the cost of merchandise. The resulting tax blow from BAT equates to a retailer being taxed at nearly the full selling price of imported merchandise, and consumer price increases of 15% or more will have to be implemented for retailers to return to their already current razor-thin profitability.
To incentive companies to purchase domestically produced products, the BAT is a value added tax that is levied based on where a good is consumed as opposed to where it is produced. The BAT is designed to balance out money flows and reduce the incentives of off-shore profits by giving tax breaks to companies that ship products to other countries and strip away tax breaks on imported goods. However, for the BAT to be effective and not impose trade distortions, foreign demand for exports must strengthen the value of the dollar, which in turn must increase demand for higher-priced imported goods. This will only work if the value of the dollar rises an estimated 20%.
The Point of No Return
Over 300 bankruptcies have been filed from retail firms so far this year. With retail currently enduring the sharpest correction in a generation, and with no end in sight, the BAT will not only drive more retailers out of business, but the systemic effect of the BAT increase will affect other industries that rely heavily on global supply chains for core products, including transportation, technology, energy and food. As all industries are absorbing increasing operating expenses, wages and the cost of capital, retailers in particular have little to no cushion to absorb an increased tax bill that may be three to five times the amount of profit. Even the current consideration of phasing in the BAT over five years will do little to stave off its negative effects since the retail correction could potentially last longer.
Although tax structures may be organized differently, the smaller retailers that make up 91% of the retail landscape are at the biggest risk from the BAT. As wholesalers and vendors of overseas merchandise are forced to increase the prices of their goods to combat the BAT, smaller companies simply do not have the buying power and scalability of their larger counterparts. If there is a dependency on foreign goods for a product line, the necessary price increases alone may turn away customers, thereby assuring the firm’s ultimate demise.
Despite the goal of encouraging companies to buy domestically, the reality is that retail firms and their customers have benefited from low-cost merchandise that is produced internationally. While it is encouraging to see increased interest in unlocking domestic production, enforcement of domestic purchasing by means of the BAT will deliver a knock-out blow to an already fledgling industry looking for relief. Implementation of BAT may ultimately have the effect of accelerating the retail retraction at such a pace that unnecessary carnage will ensue as retailers will be unable to make the necessary adjustments in time to survive.