Townley: U.S. tax reform and unintended consequences in the bike biz

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By Jay Townley, Gluskin Townley Group

At this writing it has been 102 days since the national election in November of 2016 and 30 days into the new presidential administration in 2017.

The American bicycle business is beginning to see the first jay townleyindications of what retailers from neighborhood bike shops to the largest seller of bicycles in the country and what component, accessory and bicycle assemblers, manufacturers, importers and wholesalers, of all sizes, along with the largest bicycle brands, importers and wholesalers can begin to plan for in the way of tax and regulatory changes from the new administration of the 45th president and the 115th Congress.

During the campaign the president was consistent in calling for a tax on imports and in some cases from specific countries with China getting a lot of attention. To-date the new administration hasn’t published its tax reform proposal or all of its foreign trade policies with the possible exception of Mexico.

A tax reform proposal from the Senate has also not yet emerged – but what has been advanced is a detailed tax reform proposal from the House of Representatives. 

The “Better Way” tax reform planproposed by House Speaker Paul Ryan, and Ways and Means Committee Chairman Kevin Brady would move the federal tax system toward a consumption tax, which is in many respects similar to the European value added tax (VAT).

The plan would eliminate most tax deductions and credits, including deductions for imported goods and interest expenses.

As most companies in the American bicycle business already know, under current law, the U.S. has a true “income tax,” which is a direct tax on the income of a corporation. But not on the total income; rather, the corporation is permitted to deduct both the cost of any goods sold — whether produced or purchased for resale — and general and administrative expenses like wages, advertising, interest expense, depreciation, etc.  Once a company has settled onto a net income number, a 35 percent income tax is assessed.

Under the “Better Way” tax reform plan the revenue that would be saved would be used to lower the corporate tax rate from the current 35 percent to 20 percent. Pass-through entities – which pay tax on business earnings as part of the owners’ personal taxes – would be taxed at 25 percent. The current range of seven personal tax rates from 10 percent to 39.6 percent would be compressed to three brackets of 12, 25 and 33 percent.

Under the plan, equipment and buildings (but not land) could be written off immediately rather than depreciated over several years. The last-in-first-out accounting method used by many retailers would be retained along with the research-and-development tax credit, the corporate alternative minimum tax would be eliminated, and income earned outside the United States could be “repatriated” tax-free.

As a consumption tax, the proposal includes a “border adjustment” provision that would refund to exporters the taxes they have paid on goods shipped overseas. But under border adjustment, retailers would no longer be able to deduct merchandise they import as a cost of goods. That means the full value of an imported item would be taxed, not just the retailer’s profit on the item, effectively creating a new 20 percent tax on imports.

The nation’s retailers believe this proposal would give some retailers tax costs three to five times larger than the current law and would dramatically drive up the price of imported merchandise.  The National Retail Federation (NRF) expects price increases of at least 15 percent, costing the average family as much as an additional $1,700 a year.

Even retailers that do not import directly would see higher costs since wholesalers would likely pass along the increase. The vast majority of the imported items affected are not manufactured in the United States, so there would be no opportunity to substitute American-made inventory.

This is the scenario the American boxbicycle business will face. If this proposal leads to a new 20 percent tax on imports this additional cost will be passed on to retailers of all sizes and types and all channels of trade selling bicycles and related imported products. Retail prices would, of necessity have to be increased – and based on the available projections – by at least 15 percent.

Some economists who support border adjustment say currency exchange rates would adjust to compensate for the new tax on imports, but NRF has expressed concern that the change would not come fast enough and might not be large enough.

Speaking at the NRF BIG Show in January, Federal Reserve Bank of New York President and CEO William Dudley said that he is unsure that exchange rates would fully compensate for border adjustment and warned that the proposal would lead to “lots of unintended consequences.”

Wall Street analysts are also expressing concern. RBC Capital Markets said the plan “could have a severely adverse impact on most retailers.”

Opponents

NRF and more than 150 companies and trade associations have formed the Americans for Affordable Products coalition to fight the border adjustment proposal.

Separately, president Trump has proposed reducing the corporate tax rate to 15 percent while maintaining the current income tax structure. Pass-through businesses would be taxed at individual rates of 12, 25 or 33 percent depending on the owners’ tax bracket. Repatriated earnings would be taxed at 10 percent, and manufacturers would be given the choice between immediate write-off of capital equipment investments or keeping the deductibility of interest.

The president has not included border adjustment in his plan, and has sent conflicting signals on whether he would support the House border adjustment proposal.

Experience over the last 70-years shows that the retail sector benefits from few of the tax breaks that lower tax bills for other industries, and pays the highest effective corporate tax rate of any sector of the U.S. economy, which is at or close to the maximum 35 percent.

Because of this fact, the retail industry has been a strong supporter of income tax reform that would broaden the tax base and lower the corporate tax rate. A series of economic studies sponsored by the NRF and independent organizations have demonstrated over the years that doing so would increase gross domestic product, wages and consumer spending.

Based on these studies NRF believes tax reform can be accomplished without moving the burden to consumers and has led the retail industry’s push for tax reform for years.

Unfortunately, the NRF believes the “Better Way” tax reform plan is expected to cause consumer spending to decline for at least five years and would raise prices for consumers.

The Americans for Affordable Products coalition has more than 150 corporate and association members and has launched a national campaign to show lawmakers that creating a border adjustment tax will result in higher costs for consumers on everyday necessities including food, gasoline and clothing.

Supporters stock

Emergence of the “Better Way” tax reform proposal has also created equally adamant supporters in the form of the American Made Collation.

More than a dozen chief executives from some of America’s biggest manufacturing companies called on lawmakers the week of February 13-17 to overhaul the corporate tax code and embrace the Better Way tax reform proposal that would reduce the cost of exports but penalize imports.

In a letter to House and Senate leadership, the American Made Collation argued that the current tax system penalizes American factory workers and restrains business investment and economic growth. Among the 16 executives who signed the letter are Dennis Muilenburg of Boeing, Jim Umpleby of Caterpillar, Thomas Kennedy of Raytheon and Gregory Hayes of United Technologies.

“We applaud your efforts to pursue tax reform that is both big and bold,” the letter states. “Incremental tweaks will not level the playing field for American workers or dramatically reinvigorate economic growth.”

The letter underscores the deep division within the business community as Washington debates this proposal that represent the most sweeping changes to the American tax system in more than 30 years.

As we have noted, the proposal is similar to the way European countries treat imports under the value-added tax system, and companies have long complained that American products are more expensive overseas as a result.

“This reform is consistent with the tax policies of nearly every other country in the world, and it would effectively end the ‘Made in America’ tax that creates an unfair advantage for foreign-based companies at the expense of U.S. jobs and economic growth,” the letter states.

As we have already shown, the plan faces significant opposition from the American retail industry who have warned the proposal would raise their costs — and, by extension, prices for consumers.

In addition to opposition from the retail sector, the Better Way tax reform proposal has received a lukewarm reception in the Senate.

At least two Republican Senators, Mike Rounds of South Dakota and David Perdue of Georgia, have come out against it. About half a dozen others have said they have significant concerns about how the system would work in practice, jeopardizing Republicans’ ability to garner the simple majority required for legislation to pass in Senate under budget reconciliation.

However, the White House has yet to weigh in on the proposal — and it could prove the deciding factor in the debate. President Trump has pledged to unveil a “phenomenal” tax proposal within weeks but details remain unclear. During the election, he called for slashing the corporate tax rate from 35 to 15 percent and also repeatedly vowed to slap double-digit tariffs on imports.

Adopting Ryan’s plan could fulfill both campaign promises. Trump has, however, previously dismissed the Better Way tax reform proposal as too complicated.

On Friday, February 17 president Trump visited a Boeing factory in South Carolina for a campaign-style rally.  At the end of his visit, Trump provided few hints of which way he is leaning on tax reform.  “We are going to lower taxes on American business so it’s cheaper and easier to produce products and beautiful things like airplanes right here in America,” he said.

In Washington, the Peterson Institute for International Economics held a conference that examined several aspects of the proposal, including whether it would be consistent with World Trade Organization rules and potential retaliation from other nations.

A news report that the European Union and other U.S. trading partners are preparing to challenge the Better Way proposal to overhaul U.S. corporate taxes prompted Chairman Brady to comment that the plan would survive “any challenge that they bring.”

Complete disruption

In the 30 days since the inauguration of the new president his incoming administration has fostered disruption in many areas, but so far none of these changes have appeared to directly impact the bicycle business.

However the Congress and the Better Way tax reform plan proposed by House Speaker Paul Ryan, and Ways and Means Committee Chairman Kevin Brady has emerged as having the potential to completely disrupt the American bicycle business and an ecosystem that has bumped along virtually unchanged for over 30-years.

If the Better Way tax plan continues to containa border adjustment provision and if it is supported by the White House and if it survives the Senate and if it survives Conference committee the administration has stated it would like to see tax reform signed into law before the Congressional August recess – about five months from now.

That is four big “if’s” but the Better Way tax proposal had “zero” support before the November election and it has grown a solid set of legs since the 115th Congress was gaveled into existence in January.

Take a stand – or not

What this means is – the American bicycle stock mtbbusiness has to pay close attention to tax reform from this point forward, and in the face of potentially total disruption of the whole of the import based ecosystem, including the pricing of new bicycles at all levels of distribution in all channels of trade – and has to decide if it will take a position – or simply wait out the next five months and live with what ever form of disruption results from the final tax reform legislation that is signed into law.

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