Retail Companies Get A Boost Amid Border Tax Reform Complications

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President-elect Donald Trump may have killed the Republicans’ version of  corporate tax reform, which had been pitched as an alternative to his proposed import tariffs. This measure, called a border adjustment, would tax imports and exempt exports, as part of a broader plan to stimulate job creation and production within the US. However, in his first comments on the plan, Trump called it “too complicated,” sending the stock prices of many retail companies higher. The proposal had caused an upheaval among the import-dependent companies, as it would have driven up their tax bills, and would have consequently forced them to raise the prices of their products.

Border Tax: A Bane For Retail Companies

The border tax adjustment would have affected US companies importing everything from oil products and machine parts, to smartphones and food and beverage items. This would have inadvertently forced such companies to raise their prices, accept pressured margins, or revamp their supply chains. The companies that would have had the biggest impact are the clothing and shoes 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 have seen 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, had reiterated this fact, and predicted 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 would have potentially raised 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 have impacted the price of the goods, it would have definitely resulted in a rise in the costs of the companies, and adversely affected the already pressured margins.

Import-Dependent Industries

Complications Of The Border Tax Adjustment

The border adjustment had been a key piece of the House GOP tax plan released last June. It was expected to generate more than $1 trillion over a decade, significantly offsetting the cost of cutting the corporate tax rate from 35% to 20%, according to several analysts. Meanwhile, Trump wants to reduce the corporate tax rate to 15%. Such rate cuts would reduce the incentive for companies to shift their profits out of the US. With this border adjustment plan thrown out of the window, something else will need to be done to overcome the loss in income, once the tax rate is cut down. Trump has in the past proposed a 35% levy on goods made by companies that shift their production out of the US, and then sell them back in. This move would only affect imports.

The current tax system allows companies to manufacture their goods outside the US, and then import them into the US, besides creating incentives for tax inversions. The following chart from Goldman Sachs shows how US corporate profits have been increasingly parked outside the US over the past several decades.

Leakage Of Corporate Profits

There is also a concern that the border tax plan, as constructed would not meet the US’ obligations as a member of the WTO. According to Goldman Sachs, while in the long run, it is possible that the WTO rules could be changed to allow for such a system, currently there is a big chance that it would violate the WTO prohibition on border-adjusting direct taxes.

Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such lean communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com
2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively.
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