New tax plan could hobble Target, Best Buy

Big American companies are so good at sidestepping income taxes that many pay nowhere near the statutory rate of 35 percent.

One notable exception is Best Buy Co., with an effective tax rate of about 36.4 percent through the first three quarters of its fiscal year. Best Buy should be cheering for the long-promised corporate tax reform that seems imminent.

But a likely outcome for Best Buy if the country actually adopts an ambitious Republican tax reform plan is not a celebration but a grimly determined fight to keep the doors open and the lights on.

They won't be cheering at Target Corp., either. While tax reform always creates winners and losers, it's worrisome that two of the biggest losers in the current plan could be two of Minnesota's corporate giants.

This is not a wildly speculative or alarmist conclusion. In a widely distributed report from December, analysts from RBC Capital Markets projected that Best Buy would be subjected to billions of dollars of additional taxes under the proposed system. Under that burden, the company wouldn't even come close to positive cash flow.

This tax policy being championed by House Republicans is usually called a destination-based cash flow tax, or sometimes a border-adjusted tax. It's not the only policy idea in their tax reform proposal, but it's the one getting all of the attention. In a nutshell, exporters might not pay an income tax at all or even collect a check while big importers could end up with a massive tax increase.

The term importer doesn't mean a Minneapolis boutique that sells unique items from exotic lands. Wal-Mart Stores is No. 1 and Minneapolis-based Target is right behind it on the latest ranking of importers, with Target bringing in more than a half-million "20-foot equivalent" shipping containers a year, according to the Journal of Commerce.

Richfield-based Best Buy shows up at No. 56, about where Macy's does. The retailers are joined on the list by the likes of Chiquita and Dole as well as automotive and toy companies.

Under the current setup, where products come from isn't a big tax concern, as importers and exporters are treated basically the same. What gets paid to hometown employees is a business expense but so is the cost of products that may have come in a shipping container from China.

House Republicans want a simpler tax system and lower rates but don't stop there, seeking also to reward exporters and punish importers. For people who sell products that were brought in from across the border, the cost of that product would no longer be a deductible business expense.

Think of it this way: Instead of getting taxed on profits — you know, "income" — the government would basically be taxing these companies on their sales.

For Best Buy that's a big number. Through the first nine months of the current fiscal year Best Buy had revenue of about $25.9 billion, with costs of goods sold of about $19.5 billion. After operating expenses, the taxable income came to just under $1 billion.

It's hard to know without an in-depth conversation with Best Buy executives how much of its cost of goods sold consists of imports. A reasonable guess is that it's about 70 cents out of every dollar of cost, given that high-volume consumer electronics manufacturing has long since gravitated to Asia.

So if 70 percent of the $19.5 billion Best Buy spent on the products it sold is no longer a real expense to the IRS, taxable income would shoot from less than $1 billion for the nine-month period to more than $14 billion. The tax bill would approach $3 billion. That's a life-threatening tax increase.

The industry is actively pressing its case in Washington, D.C., said Brian Dodge of the Retail Industry Leaders Association, explaining that retailers will have no choice but to try to recover the tax increase from their customers. For consumers, he said, that would mean a big price hike for "everyday items."

Retailers like Target have likely been reassured by champions of the tax reform plan that they need to relax, that as the world adjusts to the new tax code some other effects should lessen the impact on retailers. One of the things that economists expect is that currency exchange rates are going to change a lot.

This is an interesting point, although how the relative value of currencies change by a lot isn't easy to quickly grasp. Essentially what's expected is that much-lower demand for imports would slow the supply of dollars, as foreign suppliers end up with fewer of them, thus boosting the dollar's value.

Foreign buyers who want the now deeply subsidized exports will need dollars to pay for them, increasing demand for greenbacks and also raising the dollar's value. A representative estimate of how much the dollar's value could surge comes from the Tax Foundation, whose analyst landed on 25 percent.

Sure retailers will have a big tax bite, this school of thinking goes, but the much more valuable dollars they collect from their customers should buy a lot more foreign made goods. Yet at Best Buy and Target headquarters, executives have to be wondering whether this would actually comes to pass and how quickly it would happen.

Another point to consider is that if the dollar did increase in value by a lot that would of course make U.S. exports much less competitive and slow down exports. Remember, boosting exports is one of the reasons to adopt this tax policy.

If it's the case that the effect of a much stronger dollar on exports and imports pretty much offsets the effects of taxing imports and subsidizing exports, that raises just one more question — why anyone would vote to put major U.S. employers at risk just to see how this tax experiment works out.

lee.schafer@startribune.com 612-673-4302