Oil Companies Will Bear Brunt of Border Adjustment Tax

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While it’s not known what shape the Trump administration’s promised tax cuts will take, one of the more prominent changes being discussed is a so-called border adjustment tax, which would impose a tax on imports into the United States while exports would be free to leave the country untaxed. The fundamental change to corporate tax laws, if a border tax is adopted, is that corporations would no longer pay tax on income but on the company’s U.S. revenues. Exported goods would not be taxed, and imports could not be excluded from a company’s revenues.

Imported oil, according to a new analysis, will account for 50% to 65% of all tax collections from a border tax, primarily because imports of some 8 million to 9 million barrels of oil a day would be taxed at a rate of 20%. If a barrel of oil costs $50, the tax alone on 8 million barrels is $80 million (a day) that would have to be paid in cash and not included in a company’s cost of goods sold.

The only way for a company caught in that bind to avoid massive losses would be to pass the cost increase along to its customers. A 20% tax on an oil company’s cash flow would drive a 25% increase in the costs (think of it as a fee) of imported crude and refined products. According to a new paper by energy economist Philip K. Verleger Jr., “Domestic producers would realize a twenty-five percent increase in revenue at the same time if they could find US buyer.”

Verleger notes that many U.S. refiners along the Gulf Coast prefer to import heavier crude varieties from Mexico, Canada and Venezuela rather than use domestically produced lighter oils because the refineries were built or modified several years ago to process the heavier crudes. So even though the United States will soon be “energy independent” on a net basis, imports of crude oil likely will remain high.

There is good news for U.S. consumers here, Verleger writes:

[T]he US is expected to keep importing large volumes of heavy crudes, such as the oil produced in Canada or the Middle East, for these refiners. Meanwhile, greater US output would flow to other markets. The refiners would naturally seek to raise product prices. The nation’s continued dependence on product imports as well as growing foreign demand for US products would likely make it possible to pass the [border adjustment tax] BAT’s full effect through to consumers.

The other problem Verleger sees with the border tax is the notorious volatility of oil prices. In 2009, the U.S. Energy Information Administration expected crude prices to rise from $70 to $180 by 2025. The current estimate is a rise to $135 by 2025. The estimated average price of a barrel for the 10 years between 2016 and 2025 was $150 a barrel; that has since come down to $86 a barrel.

But the current price estimates could be just as far off the mark as the estimates made in 2009. Volatility breeds uncertainty, and, as Verleger notes in closing, “In this case, the Republicans propose to replace certainty with a high-stakes gamble on oil prices.”

The full paper is available at Verleger’s website.