President Trump has made a border tax adjustment a key part of his trade policy, promising to raise taxes on imports into the United States to make domestic production relatively inexpensive. The idea has also been used to keep companies from moving production abroad.
House Republicans plan on using a border tax adjustment as a key offset to lowering corporate tax rates. A recent proposal would tax all imports at the new corporate tax rate of 20% but would exempt exports from taxes. Proponents say the increased taxes on imports could generate more than $1 trillion over ten years and would partially offset lost corporate tax revenue.
With the president promising a 'spectacular' announcement on tax reform coming soon and the business community looking to seal the deal on changes to the corporate rate, tax reform and the border adjustment could be one of the biggest investing themes of 2017.
Is A Border Tax A Zero-Sum Game?
The idea of a border tax is bound to be contentious and lobbyists will be working overtime on both sides but it looks like there is enough congressional support and White House pull to push some kind of import tax through to law.
On arguments of unfair pricing by importers, proponents of the border tax say that a stronger environment for domestic producers and a lower trade deficit will push up the value of the dollar. That would help lessen the price increase on imported goods while still allowing for some of the benefits to domestic companies and the trade balance.
Even on a higher greenback, there will likely be losers in a border tax adjustment. Sales of imported goods will likely decrease and increased inflationary pressures from higher prices would be passed through the supply chain, affecting everything from shipping to manufacturing.
The furniture, apparel and auto manufacturing industries already have razor-thin profit margins of 6.0%, 6.3% and 6.4% respectively, according to data from the NYU Stern School of Business. Research by Goldman Sachs found these three to be the hardest hit among 20 industries with an impact to after-tax profit of between 5% to 15% in a border tax scenario.
Industries that could potentially benefit from a border tax including machinery (6.6% profit margin), aerospace (7.2%) and railroad transportation (18.3%) were estimated to see a boost of nearly 5% to profits.
Winners And Losers On Both Sides Of A Border Adjustment
Domestic producers of large capital goods like aircraft and machinery could be beneficiaries of the trade adjustment. General Electric (NYSE: GE) and Boeing (NYSE: BA) helped form the lobbying group American Made Coalition to support the border tax adjustment.
General Electric is one of the ten largest employers in the United States with 125,000 employees at manufacturing plants and its headquarters office. Sales rebounded in 2016 after a difficult year for the oil & gas segment but the company has repositioned to focus on its industrial segment. Not only might GE benefit from a border tax adjustment but it could be a prime beneficiary of future infrastructure spending.
The company has an unbelievable $99 billion in balance sheet cash, nearly 38% of its market cap, and has aggressively paid down debt over the last two years. Any increase in sales from a border tax adjustment, fiscal stimulus or a continued rebound in energy could lead to a bump in cash flow that could restart the company's share buyback program or boost the 3.3% dividend yield.
Boeing is America's biggest manufacturing exporter and has 84% of its 148,000 global workers located in nine states. Its aircraft assembly building in Everett, Washington is the largest building in the world by volume and covers 98.7 acres.
The company has a backlog of 5,700 commercial aircraft, giving it long-term stability in sales and the re-emergent defense spending cycle looks to boost sales over the next several years. The company is a cash flow machine, generating nearly $7.9 billion in free cash flow last year and allowing it to return $7 billion through a buyback on top of the $2.7 billion spent on the dividend.
Among the losers in a border tax adjustment, consumer retailers and apparel could be hit especially hard. The United States imports more than $80 billion in apparel every year, well over the $6 billion exported. According to FiveThirtyEight, producers in China alone account for 38% of the total and all of Asia accounts for two-thirds of apparel imports.
Wal-Mart (NYSE: WMT) is secretive about how much of its merchandise is imported but has come under fire for mislabeling products as made in America to counter claims that the company imports most of its products. The Economic Policy Institute estimated that Wal-Mart imports at least $49 billion from China alone and accounted for a full 15% of the Sino-U.S. trade deficit from 2001 to 2013. For its part, Wal-Mart has come together with Target, Saks and other retailers to form the Americans for Affordable Products group to fight the tax adjustment.
Wal-Mart has been hit by competitive pressures from both online retailers like Amazon and discount stores like Dollar General undercutting its low-price model. Sales have grown at a paltry 0.9% annualized pace over the last three years while operating expenses have grown at a 2.9% rate over the period.
Wal-Mart is likely to be one of the hardest hit on a border tax adjustment because of its low-price business model. The company would have a difficult time increasing prices if the cost of its imported products increased. Its 3% profit margin doesn't leave much room for error, and the company would likely have to drastically reduce operating costs to stay profitable.
Risks To Consider: Any border tax is likely to be included in larger tax reform, which could drag on in Congress for a year or more.
Action To Take: Position in companies and sectors that could see a boost from tax reform and a border tax while avoiding shares in sectors that import parts or products.