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Will the BAT Be the Tax That Changes Everything?

There are lots of reasons for California Representative Devin Nunes to be excited about his job these days. As chairman of the House Intelligence Committee, he is leading a classified investigation into Russian interference in U.S. elections, and as a member of President Trump's transition team, he played a key role in staffing the new Administration. But if you talk to the 43-year-old Congressman, it soon becomes clear that nothing gets him going quite like a wonky hunk of tax policy that means nothing to most Americans: the destination-based cash-flow tax with border adjustment--or BAT, for short.

"It changes absolutely everything," Nunes told TIME recently, from his ground-floor office across the street from Capitol Hill. "It moves us to a fundamentally new system."

Nunes is one of the most vocal champions of the central, mind-bending provision of the House Republican plan to overhaul the corporate tax code. It would lower the corporate tax rate to 20%, from 35%, eliminate levies on all U.S. exports and impose a 20% tax on imports. It's a mix that is expected to raise an estimated $1 trillion in federal revenue over a decade, according to the Tax Foundation, making it the linchpin for passing any comprehensive tax-reform bill this term. "It's a really, really big deal," Nunes says of the proposal that House Republicans hope Trump will formally embrace in the coming weeks.

But the tax has also earned really, really big enemies, igniting something of a conservative civil war in Washington, with House Republican leadership lining up in favor and deep-pocketed activists and lobbyists vehemently opposed. The BAT, opponents say, would force big-box stores out of business, drive up the cost of everything from baby formula to avocados and potentially spark a devastating trade war. "I think we need to be realistic about what a huge risk this is for our economy," says David French, the top lobbyist for the National Retail Federation.

It's a fight both Nunes and House Speaker Paul Ryan are eager to have, though they admit that the complexity of the plan makes it difficult. "The longer it takes to explain," warned Senator Tim Scott, a Republican from South Carolina, "the harder it is to implement."

But proponents of the plan--which Trump hinted at in his address to Congress--say it is bold and revolutionary at a time when the country is clamoring for big changes that would curtail corporate taxes and encourage more U.S. manufacturing. The BAT is not just a new tax rate, after all. It would burn down the current tax code and replace it with something entirely new. "This is the most dramatic change to business taxation ever proposed in the United States, period," said former John McCain economics adviser Douglas Holtz-Eakin, who supports the plan.

When it comes to the state of the tax code, there's a surprising amount of consensus in Washington: liberals, conservatives and every President from Bill Clinton to Donald Trump agree that the corporate tax is broken, ineffective and needs to be fixed.

The problem, in a nutshell, is that the 35% corporate tax rate is among the highest in the developed world. But because of loopholes, it produces less federal revenue, as a percentage of GDP, than most other countries'. The current system also creates an incentive for companies to perform feats of legal acrobatics, like relocating corporate headquarters and shuffling intellectual property to far-flung foreign locales, to shield their balance sheets from the IRS.

That's where the BAT comes in. In theory, this little tax will fix those big problems. Instead of taxing corporate profits, the BAT taxes corporate cash flow. That means it doesn't matter where a company's headquarters are located or where its intellectual property is housed. All that matters is where it sells its products. If it sells its products in America, it pays 20% on what it makes. If it sells its products abroad, it pays no U.S. corporate tax at all. (Foreign taxes would still apply.)

The BAT also simplifies the laundry list of deductions and carve-outs buried in the current tax code. Under the BAT, companies would be allowed to deduct from their taxable income U.S.-based labor costs and expense capital, like machinery, immediately upon purchase. But they would no longer be able to deduct net interest, asset depreciation or the cost of any imported goods.

This is how it would work: if a company makes a T-shirt in Oklahoma and sells it in California, it deducts its capital and labor expenses, and then pays a 20% tax on what it made from that T-shirt. If a company imports a T-shirt from China and sells it in California, then it doesn't get to deduct the cost of the T-shirt, but it still pays 20% on what it makes selling it. If a company makes a T-shirt in Oklahoma and sells it in France, it pays no U.S. corporate tax on its sales at all. Nada. Zero. Zilch.

On paper, it's pretty clear to see why companies that are primarily exporters, like Boeing and Dow Chemical, stand to gain from the tax--and why companies that are primarily importers, such as Walmart and Target, are nervous.

Americans for Affordable Products, a coalition of big-box stores, mom-and-pop outlets and other opponents of the BAT, say retailers won't be able to simply shift their supply chains stateside. There aren't enough U.S. factories--or independent contractors on Etsy--to keep up with demand. Instead, those retailers would pay the 20% tax on imports while passing on the cost to consumers in higher prices, resulting in what the National Retail Federation estimates will be a $1,700 hit to American households in the first year the tax is enacted.

But such calculations tell only part of the story, say economists from both ends of the ideological spectrum. Since the tax has the effect of essentially subsidizing exports and penalizing imports, textbook economic models predict it should have the effect of strengthening the value of the U.S. dollar by as much as 25%. That, in turn, would make imports cheaper and exports more expensive. So the effect on store prices over time could be entirely offset. Consumer prices may rise in the short term, but then bounce back to normal. "It comes down to supply and demand," said Larry Lindsey, former director of the National Economic Council, under George W. Bush.

Or that's the theory, at least. Reuven Avi-Yonah, a law professor at the University of Michigan who has studied the tax extensively, says that in the real world, it's difficult to predict foreign exchange rates and to foresee how they will affect the global economy. "It's misguided to think that it'll behave rationally," he says.

That's to say nothing, he added, of the potential legal complications of the new tax. If our trade partners interpret the BAT as an opening volley in a trade war, U.S. exporters could very well see themselves on the losing side of international sanctions. John Connaughton, a University of North Carolina at Charlotte professor of financial economics, predicts that other countries will file legal challenges "out the wazoo" at the World Trade Organization, demanding that it declare the BAT a violation of international trade laws.

In a normal year, with less mercurial politics and a more predictable White House, the BAT would be dead in the water. There are too many short-term losers, too much opposition from powerful industry actors and too little consensus among Republicans. The last big overhaul was in 1986, when Nunes was in middle school. Even then, a version of the BAT was on the table, but it wasn't taken seriously on the Hill, in part because it was considered politically unfeasible.

But it's worth noting that this isn't a normal year. Trump, voicing the id of a populist base, has already made confetti of long-held Republican orthodoxy, embraced incendiary rhetoric and promised policies that have traditional business-side Republicans running for the hills. The idea that he could be the first President in over three decades to embrace a revolutionary policy with big risks and big rewards is not out of the question. "There have been a lot of dark times over the years," Nunes says, describing his battle to get the Republican caucus to seriously consider the BAT. "I'd say we're closer now than ever."

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