President Trump threw trade experts for another loop Thursday by endorsing — or seeming to endorse — a new tax system for imports and exports that he said would "reduce our trade deficits (and) increase American exports." Not so incidentally, he also said it "will generate revenue from Mexico that will pay for the wall."
The tax would help pay for the wall he intends to build on the Mexican border to keep illegal immigrants out, which is estimated to cost as much as $14 billion.
He appeared to be buying into a proposal by House
Trump spokesman Sean Spicer talked about a 20% import levy on Mexico, but he may have been referring to the House Republicans' goal to cut the U.S. corporate tax rate to 20%. That would be the residual tax rate on imports, as well as to domestic goods sold in the U.S. Only U.S.-made goods exported abroad would be exempt.
And that's not the only element of the plan that's unclear. Here are some questions and answers about Trump's plan specifically and the border adjustment tax in general.
How does the border adjustment tax work? In simplest terms, the House proposal would change the basis of the corporate tax from where a company is located or where its goods are produced to where its products are used.
In other words, a gadget produced in the U.S. and exported to, say, the Netherlands would be tax-exempt. But a smartphone produced in China, whether by Apple or China's Xiaomi, would be taxed when it's imported into the U.S.
How does this change business behavior? Theoretically, it removes the incentive of American companies to relocate their tax homes overseas, the controversial process known as inversion. The location of the company or its factory wouldn't matter, just the place it's selling its goods.
"Tax considerations thus would not influence business decisions as much as they do today," observed tax expert Edward Kleinbard of USC in a recent op-ed in The Times. The change, he added, "would largely eradicate the 'stateless income' tax planning games through which U.S. multinationals carry on their books more than $2.5 trillion in very-low-taxed offshore earnings, at the expense of the United States and other countries where those firms are actually doing business."
Who would be the business winners and losers from a border adjustment tax? In general the big winners would be export-oriented U.S. companies. Think Boeing, which exports most of its aircraft overseas, and therefore might be in a better position to compete with foreign plane manufacturers such as Airbus.
Retailers, oil companies, automobile manufacturers and consumer goods manufacturers would be losers. They're all dependent on imports. Department stores sell garments and furniture made overseas, which is why Wal-Mart is prominent among the opponents. Although the U.S. is no longer a net importer of oil, it's still a major importer. Auto companies build their cars with foreign-sourced parts. Consumer gadgets sold in the U.S., such as computers and smartphones, are made in foreign factories, which would render them taxable at the border
How would consumers fare? It's likely they'll pay more at the gas pump, more for autos and more for items such as clothing, which are mostly made from imported material and by foreign labor.
Some advocates of the border adjustment tax say that consumers may not pay a noticeable increase. Their theory is that the change would raise the value of the U.S. dollar, which would reduce the cost of imported goods in dollar terms.
Kleinbard isn't so sure. If the dollar rises, he wrote, "Wal-Mart shoppers will pay the same prices after the 'border adjustable' tax as they do today, and exporters will export the same amount of goods and services."
But that assumes that currency rates follow the economic textbooks. If they don't, the consequences could be dire. "The tax's burden will fall on consumers through higher prices, rather than on corporate profits," he wrote. (He adds that if the dollar does rise, U.S. investors holding foreign assets could get hammered. They could "lose trillions of dollars in wealth, because their investments suddenly will be worth less in dollar terms. By voting for this radical reform, politicians may be putting their careers into the hands of the currency markets.")
Would this be good for the U.S. Treasury? Proponents say yes, because imports, which would be taxable, currently exceed exports, which would be tax-exempt. By some reckoning, the gain would be $1.2 trillion over 10 years.
How do liberals and conservatives see this change? Surprisingly, economic thinkers are more in agreement with each other than one might expect. Economists at both ends of the economic spectrum have argued that border adjustment, in principle, might work to the advantage of both shareholders and workers.
The corporate tax is typically seen as a burden on capital — that is, shareholders — so conservatives think that reducing it will be good for the free market. But America's current tax structure encourages companies to invest in lower-tax countries, which shifts "at least some of the corporate tax burden to domestic U.S. labor," economist Alan J. Auerbach of UC Berkeley wrote for the liberal Center for American Progress in 2010. The change in tax structure, he argued, could relieve downward pressure on wages and salaries.
Does this make Mexico a target of trade policy? Mexico would be a target of this policy only to the extent that it's a net exporter to the U.S. But that's a category that includes most of America's trade partners, not just Mexico.
Mexico's $59-billion trade surplus with the U.S. — the amount by which its America-bound export exceed its imports — ranked fourth in 2016, after China ($319 billion), Japan ($63 billion) and Germany ($60 billion). Even among trading partners that import more from America than they export, the mismatch is much smaller: The biggest trade deficits among American trading partners were those of Hong Kong ($25 billion) and the Netherlands ($22 billion).
Is this even legal? Considerable debate exists about how the House proposal conforms to international trade law. A unilateral attack on the Mexican trade deficit would surely violate
Kleinbard observed that conflicts between the new policy and WTO law would "defy any simple fix" and present "a recipe for years of dispute, business uncertainty and potential retaliatory tariffs." In other words, it's not a change to be made hastily.
Former Treasury Secretary Lawrence Summers shares those doubts. Writing in the Financial Times on Jan. 8, he predicted that the change in tax structure "will be seen by other countries and the World Trade Organization as a protectionist act that violates U.S. treaty obligations. Proponents may argue that it should be legal because it is like a value added tax, but the WTO is very clear that income taxes cannot discriminate to favor exports." While the WTO ponders the legalities, he wrote, "protectionist acts by other nations would be licensed immediately."
How would this pay for Trump's wall? That's the $14-billion question. The answer is that it wouldn't, directly. Trump could say that he's diverting the money for the wall out of the general gains from the import charges. But House tax-writers have acknowledged that their corporate tax changes will have to be revenue-neutral — that is, the revenue gains would have to be used dollar-for-dollar to pay for corporate tax cuts. Otherwise the change could be vulnerable to a Democratic filibuster in the Senate.