Orchestrating the task fell to Paul Ryan. He made the mistake of helping write a bill that reflected Republican orthodoxy, but ran counter to the interests of Charles Koch.
Paul Ryan’s mistake was caused by seemingly good intentions. He partnered with the Texas Republican Kevin Brady, head of the powerful House Ways and Means Committee. They wrote a bill that would dramatically cut income taxes for US corporations and middle-class families, while also remaining “revenue neutral,” meaning that it would not increase the national debt. This might have seemed eminently practical because lowering the debt had been the campaign platform of Republicans for at least seven years. But the approach was fundamentally flawed in Charles Koch’s eyes.
This flaw arose because Paul Ryan was trying to do three things at once: avoid adding to the US deficit, cut corporate tax rates, and meet the desires of Republican voters who elected Donald Trump. Ryan thought he could meet all of these needs by using an obscure tax provision called the Border Adjustment Tax (technically it was a border adjustment to the federal income tax, but it became widely known as the Border Adjustment Tax, or BAT), which became a vital pillar of Ryan’s tax plan. The BAT is what drew the Koch network’s opposition.
It is easy to see why Paul Ryan would have been seduced by the logic of the BAT. A similar adjustment was already in place in more than 140 countries and wasn’t exotic or particularly controversial.II There was strong evidence that the BAT would accomplish one of Donald Trump’s most important campaign platforms—boosting economic growth inside US borders and discouraging companies from shifting their factories overseas. Creating a BAT would also help raise money to offset the massive cuts in corporate income tax that Ryan proposed, taking the rate from 35 percent down to 20 percent. If the corporate tax rate was cut with no other changes, it would dramatically increase the deficit. The BAT provided an elegant solution. It would allow the government to raise money—roughly $1 trillion over a decade—that could shore up the budget.
The BAT would do this by making a seemingly subtle shift to the US corporate income tax system that had tremendously large effects. Under the current tax code in 2017, US companies were taxed based on the profits they earned from things that they produced in the United States. Under the BAT, companies would be taxed on profits from the things they sold in the United States. This difference, although it seemed obscure, would upend the economic logic that enticed companies to send their factories to Mexico and China. In essence, the BAT was a big tax break for exporters.III Under the BAT, exporters who made things in the United States and sold them overseas would not be taxed on income from the sale. Conversely, if a company produced goods in China and sold them in the United States, the company would pay a 20 percent tax on the profit.
The end result of this tax shift was decidedly Trumpian. Most experts predicted that the BAT would encourage companies to locate their factories in the United States and make things to sell overseas. The change wouldn’t be dramatic, but it would move the country closer to Donald Trump’s vision of “America First.” The existing US tax code of 2017 did the opposite—it encouraged companies to move their production to low-cost countries like China (because the United States didn’t tax profits from overseas production) and sell them in the United States. For this reason, Ryan began to call the existing tax code the “Made in America Tax.” He bolstered his case for the BAT with poll numbers—the new surge of Trump voters supported the idea of a BAT overwhelmingly. They wanted to do anything they could to bring factories back to Wisconsin and Michigan.
Charles Koch opposed the BAT for two reasons. The first was ideological—the BAT would impose a new tax, and Koch’s network opposed all new taxes. The second reason was more central to Koch Industries’ business. The BAT posed a grave threat to the company’s profits. In December of 2016, before Donald Trump was inaugurated, Koch’s lobbying office funded a study by a consulting firm called the Brattle Group. Unlike other groups that published Koch-funded studies, the Brattle Group clearly acknowledged Koch’s support in the beginning of the report. Kevin Neels, a coauthor of the study, said that Koch initially insisted that its support remain secret. But hiding Koch’s financing would have violated the Brattle Group’s policies, so Koch eventually agreed to let Brattle disclose it.
The study showed why Koch might have deep concerns with the BAT. The tax could carry a high cost for energy companies that imported crude oil or other fuels from overseas. The Brattle Group report claimed that the BAT, by imposing a 20 percent tax on imported oil sold inside the United States, would raise gasoline prices by about 13 percent, or roughly 30 cents per gallon. This could be a nightmare for oil refineries that imported crude and sold it domestically. The damage could potentially be twofold and severe. First, it might cut into the refineries’ profit margins. Second, and most dangerous, the tax might dampen demand for gasoline by raising prices. If that happened, it would stoke demand for alternative energy sources, compounding the long-term problem of peak demand for gas.
Koch Industries would later insist that it opposed the BAT only for purely ideological reasons. The company argued that it would have actually benefited if the border adjustment was imposed because the tax would raise consumer prices for gasoline and other products Koch sold. But the effect of a BAT on Koch’s business would be complicated. There was strong evidence that the tax could pose a threat to Koch Industries’ oil refinery in Pine Bend, which was still considered to be the company’s “crown jewel.” After decades, Pine Bend still benefited from occupying a stunningly profitable bottleneck in the US energy system. Cheap oil from Canada’s tar sands piled up at the US border without many buyers except Koch, and Koch could still sell its refined gasoline into midwestern markets where prices were relatively high thanks to a lack of refining capacity. Pine Bend was largely depending on imports, and the BAT would make those imports more expensive.
In the month of February of 2017 alone, Koch Industries bought 9.55 million barrels of Canadian crude oil at Pine Bend. The average price at that time was $39.41 a barrel. If the BAT was imposed, the government would be entitled to $75.3 million in new taxes on products Koch made from that oil, for just one month of production. More importantly, the new tax might wipe out some of the price advantage that Koch had long realized by purchasing Canadian crude. Once the BAT was imposed at 20 percent, the cost of Canadian crude would be $47.29. That was still an advantage over the cost of a barrel under the WTIIV contract in Texas (which was $53.47), but far less of an advantage than before. And this change would be permanent. The crown jewel might be tarnished, and long-term sales would be hurt by the higher cost of gasoline.
Koch’s public relations team claimed that the Pine Bend refinery could actually benefit from the BAT, because the tax would raise gasoline prices. It was difficult to disprove this hypothetical argument, but three former Koch commodities traders said that it was almost inconceivable that a BAT would benefit Pine Bend. One oil trader, intimately familiar with the economics of Pine Bend, said there was “no scenario” under which the refinery would benefit from a border tax. Another pointed out that any 20 percent increase in the cost of inputs could hurt a refining operation, even if gasoline prices rose. Regardless of the hypothetical scenarios from which the Pine Bend refinery might benefit, there was no doubt that a BAT could be disruptive to Koch’s refinery business.