By Ian Adams and R.J. Lehmann
As appeared in The Hill.
President Trump signaled during last week's address to a joint session of Congress that he is, in fact, on board with House Republicans' so-called "border adjustment" proposal, despite earlier indicating that he was not. Of course, getting on the same page on the border tax plan, also known as a “destination-based cash flow tax,” would be key to fulfilling Treasury Secretary Steven Mnuchin's pledge to wrap up comprehensive tax reform before Congress' August recess.
But border adjustment remains controversial on the right, drawing opposition from the Koch network, from Steve Forbes and, perhaps most importantly, from the nation's retailers, who produced an infomercial parody of "BAT" that ran this past week in a high-profile slot during Saturday Night Live.
A less-appreciated, but arguably just as consequential, debate is currently playing out in the insurance world, where a group of large domestic insurance companies long have argued for a system somewhat similar to border adjustment, claiming it would close what they call a tax “loophole” that gave foreign-based insurers a competitive advantage. That proposal—which has been sponsored by Sen. Mark Warner, D-Va., and Rep. Richard Neal, D-Mass.—largely would serve to make insurance more expensive and less competitive. But as bad as the Warner-Neal plan was on that front, the border adjustment proposal is many times worse.
The key is how the system would treat reinsurance, generally known "as insurance for insurance companies." Reinsurance is a form of risk transfer focused on tackling large and irregular risks, a way for the home, auto and business insurance companies you know to protect themselves from catastrophic losses. Instead of maintaining the huge capital load that would be needed to satisfy all their outstanding risks, primary insurance companies purchase coverage from reinsurers, many of whom are based overseas.
While U.S. insurance companies currently write off the cost of reinsurance as a legitimate business expense, the border adjustment tax would prevent insurers from doing that if the reinsurer was based overseas. This is a remarkably bad idea, and not just for the usual free-trade reasons. To keep reinsurance inexpensive, reinsurance companies take on disparate and unrelated risks from all over the world to create a pool of capital that is both large and diversified. It's not just the case that insurance companies import reinsurance – they also export risk. The alternative is that, instead of being pooled by a global reinsurer with risk of tsunamis in Japan and earthquakes in New Zealand, U.S. risks like Florida hurricanes and California earthquakes would all be concentrated here. That's a terrible risk management strategy.
A recently released study by the Brattle Group finds the effects of the border adjustment would be to reduce the supply of reinsurance by between $15.6 billion and $69.3 billion and force U.S. consumers to pay between $8.4 billion and $37.4 billion more each year just to get the same coverage. Overall, property and casualty insurance rates would be expected to rise by 3.4 percent, but some lines of business would see even bigger price hikes, including 3.8 percent in workers' compensation; 5.7 percent in earthquake insurance; 7.2 percent in boiler and machinery insurance; and 7.8 percent in aircraft insurance. Those are hardly ways to make American manufacturing great again.
The insurance debate need not necessarily doom the entire border adjustment proposal. The BAT essentially is based on the VAT, or value-added tax, which is a system that has been implemented in more than 160 countries around the world. However, with the lone exception of China, every other country that uses a VAT excludes insurance and reinsurance from the tax. House Republicans might have to do the same if they want to have any hope of making their August deadline.
Ian Adams and R.J. Lehmann are both senior fellows with the R Street Institute in Washington.