Jeff Cayley's retail cycling business may be based in Newbury Park, California, but it's very much a global enterprise.
If President Donald Trump gets his way on tax reform, retailers like Cayley may need to revise their business plans to focus more on U.S. consumers and product vendors.
"We are a retailer for a number of brands that do their manufacturing in various places around the globe," says Cayley, who founded Worldwide Cyclery in 2011. "In the high-end segment of the bicycle industry, most of the manufacturing is done in Taiwan and Vietnam with a little U.S.A., Canada, and E.U. sprinkled in." About a third of his company's sales come from customers outside the U.S., in such places as Australia, South America, and Russia. "Those countries are big for us," adds Cayley, whose 10-person company brought in $5.3 million in revenue last year. Also that year, Worldwide Cyclery landed at No. 874 on the Inc. 5000 list of the fastest-growing private companies in the U.S.
Cayley is concerned about Trump's recent support of a popular House Republican tax reform proposal known as a border-adjustment tax. That plan, if approved, would modify the current federal tax system by adding a 20 percent tax on all imported goods. Under that plan, much of Cayley's inventory would cost more. He'd also lose out on being able to deduct the cost of his company's goods purchased from outside the U.S.
Many companies, both large and small, are similarly anxious about the plan. More than 100 retailers, including The Gap, The Container Store, and Wegmans Food Markets, have formed a coalition called Americans for Affordable Products to oppose the proposal, which they fear will drive their costs higher.
A key supporter of the coalition is the retail industry trade group the National Retail Federation. David French, NRF's senior vice president for government relations, considers border adjustment a "risky experiment" that will ultimately hit U.S. consumers with higher prices.
To be sure, Trump may instead opt to push for his earlier plan to impose a 35 percent tariff on manufactured goods made by American corporations outside the U.S. He has also talked about implementing a 20 percent border tax on just Mexican imports, which he said would help pay for a wall along the border of Mexico.
Even so, Republicans in Congress will likely push for more comprehensive reforms. The border adjustment alone could be a significant moneymaker, and as such, it could help fund other reforms that both Congress and Trump want. The discussion among lawmakers is expected to begin in earnest in the next two or three weeks, according to Trump's recent comments to the business community. Lawmakers had planned to take up the issue after Congress repeals the Affordable Care Act and installs a replacement health bill, which is looking less likely.
Behind border adjustment
So what exactly is border adjustment? And what are the implications for U.S. businesses, should it become law? Currently, U.S. businesses pay federal income taxes based on where they're located and where their products are produced, as opposed to where they're sold. With the border-adjustment plan--which is part of a larger House Republican proposed tax-reform agenda--a business's federal taxes would instead be calculated based on where its products or services are sold. It's worth noting Trump is also proposing to drop the corporate tax rate to 15 percent or 20 percent from the current upper level range of 35 percent.
Another key feature of the plan: U.S. companies would be unable to deduct expenses incurred outside the U.S.; they'd be able to deduct only wages and costs borne within the U.S. The plan, dubbed A Better Way, was proposed in 2016 by House Speaker Paul Ryan (R., Wisconsin) and Ways and Means Committee Chairman Kevin Brady (R., Texas).
The proposal would be transformative for U.S. businesses, because it changes the U.S. tax system into one that is consumption based. "As far as I know, the U.S. would be the first country to try to make its corporate income tax border adjusted," says Scott Greenberg, an analyst at the Tax Foundation, a conservative-leaning think tank in Washington, D.C.
Should it pass, a border adjustment is expected to raise $1.2 trillion over 10 years, according to the nonpartisan Urban-Brookings Tax Policy Center in Washington, D.C. That could persuade the president to back the proposal, since it could help pay for other initiatives like cutting the corporate tax rate.
Crushing consequences, or not
The border adjustment would also hold significant consequences for the U.S. economy. Namely, companies might push prices higher if their import costs suddenly rise. The National Retail Federation estimates that the effort could cost the average American family $1,700 in the first year.
Plus, there's a chance, albeit a low one, that other countries will retaliate with their own border adjustment. While it could happen, it's unlikely, because more than 160 countries already have a value-added tax, a consumption tax which acts similarly to the proposed border adjustment, according to Greenberg.
What's more, the expected effect on the U.S. dollar would negate some of the hardship that the plan would impose on importers. As Greenberg explains, a border adjustment exempts exports from federal income taxes, so economic theory suggests demand for U.S. goods and dollars should rise. By contrast, adding a tax on imports would in theory reduce the demand among U.S. consumers for non-U.S. goods and currencies. The upshot is you'll get a stronger U.S. dollar, relative to other currencies. So while importers may face higher costs, their dollars will presumably go further.
"As we've seen in other countries, there is good reason to expect the U.S. dollar will move more or less as the theory expects," says Greenberg.
Robert Willens, an independent tax and accounting analyst in New York, has doubts about that prediction. "I would be skeptical that there would be a direct and immediate reaction to the tax on the dollar," he says, in reference to the tax's expected impact on the value of the U.S. dollar. "If The Gap has higher costs, it needs to raise its prices to keep its margins intact." He adds that it will inevitably put some companies in a bind. "You can [raise prices] only to a certain extent." At some point, consumers just won't bite.
Joseph Rosenberg, a senior research associate at the Tax Policy Center, anticipates that some companies will look to merge to offset a border adjustment. If a U.S.-based manufacturer only exports--that is, it has zero U.S. sales--that company's federal taxable income, for border-adjustment purposes, would be nil. "All of those deductions would have nothing to offset," says Rosenberg. By contrast, a company that only imports would appear highly taxed. "If exporters are not able to claim credits for their exempt exports, they may need to merge with an importer," he adds.
The border adjustment could also lead to more complexity--and that could drive up costs for smaller companies, which tend to have few resources to devote to compliance, suggests Rosenberg. If border adjustment becomes law, domestic and foreign sales would need to be tracked separately since only U.S. sales would be subject to federal income taxes. "There are still a lot of specifics and details that need to be worked out," says Rosenberg, adding: "Little details can matter a lot."
Cayley says the uncertainty makes planning for Worldwide Cyclery's future tricky. "At this point, it's pretty hard to speculate what'll happen," he says. His company has been adding more customers in the U.S. in the past six years, which he says would pick up if the border adjustment goes through. "We'll continue to focus on our domestic business."