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Is A Border Adjustment Tax On Imports Desirable?

Expectations from the BAT are either exaggerated or overlook significant likely adverse effects, writes Harsha Vardhana Singh.

A signage for port control office at the Kirshnapatnam port, in Andhra Pradesh. (Photographer: Prashanth Vishwanathan/Bloomberg)
A signage for port control office at the Kirshnapatnam port, in Andhra Pradesh. (Photographer: Prashanth Vishwanathan/Bloomberg)

There was recently a BloombergQuint news report that the Government of India is considering a Border Adjustment Tax, by imposing taxes on imports equal to the duties and taxes on domestic products that, unlike the Goods and Services Tax, are not-creditable and non-refundable. These taxes include, for example, duties on electricity and fuel, clean energy cess and mandi tax.

The BAT is being considered to level the playing field for domestic products and imports, and thereby boost domestic output by making imports more expensive.

The main aim, one would expect, is to help remove the cost disadvantage currently faced by many Indian products in the local market. It might also be to enable Indian suppliers to play a more important role in global value chains, but that is a misconception as this column shows below.

Another reason for the BAT maybe to generate additional tax revenues.

Yet, some of the reported discussion on the BAT suggests a protectionist mindset, with an expectation that there will be no serious retaliatory reaction from other countries, and it could be imposed up to the level required to meet specific objectives.

Most of these expectations from the BAT are either exaggerated or in certain cases overlook significant likely adverse effects on ease of doing business and facilitating exports.

Inadequate Benefit

A BAT on imports that does not exceed the indirect taxes levied on domestic products is allowed under the WTO. However, if the tax imposed exceeds the indirect taxes levied on the like domestic product, that would violate WTO rules. This could occur both with a higher BAT imposed on imports than the corresponding tax on the domestic product, or if a refund mechanism applies for some of the taxes on domestic products used as inputs but not for the imported product.

A BAT on imports is conceptually equivalent to the scheme for Remission of Duties and Taxes on Exported Products or RoDTEP, in terms of its coverage of unrefunded taxes.
While the rates for RoDTEP applicable to different products are yet to be finalised, initial estimates suggest low levels that go up to about 3%. That would be a small fraction of the overall cost disadvantage estimated for several Indian products, at reportedly 10% to 15%.

Therefore, a BAT, that genuinely compensates only for unrefundable local taxes, is not going to address the issue of the higher cost of domestic production.

Thus, if BAT is implemented consistent with WTO requirements, it will likely have a small impact in terms of its tariff equivalence. Further, if the Indian market is significant for the exporter to India, the BAT might prompt a small reduction in their price to maintain market share. As the BAT would unlikely bridge the overall cost disadvantage local goods face, cost competitive imports would continue to remain less costly than Indian products.

Impact On Exports

Such a BAT would also not make a significant change in improving the situation for Indian producers to become part of global value chains. In fact, it could be harmful.

Over 30% of India’s merchandise imports are intermediate goods, used for exports and domestic sales. OECD data shows that Indian exports from a majority of its industrial sectors have an import content ranging from 20% to 40%.

To the extent import—and domestic—prices increase due to the tax, this would raise slightly the cost of domestic and imported inputs in Indian exports. This could make it more difficult for Indian products to compete with other nations vying to replace their competition.

Any price increase would reduce the attractiveness of Indian products in the highly-competitive market global value chain market.

Inviting Retaliatory Action

Consider alternatively the situation of BAT exceeding the corresponding taxes on domestic products. This would violate the WTO. Countries exporting to India could challenge the BAT under WTO. Since the dispute settlement mechanism under the WTO is not fully functional due to an inactive Appellate Body, it is possible that certain countries might impose their own retaliatory duties on India’s exports to them, similar to the response of some to the increase in the U.S. import tax on aluminium and steel.

Larger problems are likely to emerge with a protectionist approach.

  • A protectionist BAT will have a significant adverse impact on operational conditions, reducing the efficiency and competitiveness of domestic producers.
  • Moreover, a protectionist policy may at best encourage production for the domestic market, and not exports nor global value chains.
  • A protectionist BAT would tilt the playing field towards sales in the domestic market, away from exports.

Ironically, it will also reduce the effective value of support under RoDTEP, with the domestic market providing a larger margin than that available to exports. To the extent that the BAT on imported inputs could be reimbursed for exports while the price rise of domestic inputs is not so reimbursed, exporters will have an incentive to rely more on imported inputs compared to domestic ones.

More importantly, a protectionist BAT will increase the present obstacles to exports and productivity due to the problems linked to the manner in which domestic policies are implemented.

Feedback from Indian exporters suggests that one of the most important reasons for uncertainty and cost increase for domestic producers and exporters is the manner in which policy is implemented. Larger the number of duties, taxes, or regulatory requirements, particularly at the border, more the delay and increase in operational costs for Indian producers. An important reason for this is the silo-based approach of the implementing agencies. For example, the focus of revenue collecting agencies (e.g., customs) is to increase revenue in various ways, irrespective of the adverse impact on domestic operational efficiency or exports.

If an additional duty such as a BAT is implemented with a protectionist approach, this will magnify the operational burden for domestic producers and result in a setback for ongoing efforts to improve facilitation, competitiveness, increasing exports, or improving links with global value chains.

The experience of countries such as China and Vietnam, shows that they have managed to increase their exports manifold through a combination of policies that facilitated operations, improved cost and quality competitiveness, provided incentives including financial support, and reduced delays to enable timely turn-around for products to be imported, processed and then exported.

A protectionist approach, which appears to be part of the discussion for BAT, will reduce performance in all these policy areas, adversely affecting export capabilities and the operational efficiency of both industry and the policy-implementing system.

Harsha Vardhana Singh is former Deputy Director General of the World Trade Organization.

The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.