Publish in Perspectives - Tuesday, March 14, 2017
A Border Adjustment Tax would create a complex tax system for trade and make US exports more expensive, the author argues. Here cars crossing the U.S.-Mexico border. (Photo: US Commerce Department)
What would be the effect of the Border Adjustment Tax on NAFTA and the rest of the hemisphere? A red-hot mess.
BY CHRISTOPHER SABATINI
Donald J. Trump’s policies regarding global trade remain unclear and contradictory. With the rejection of the TransPacific Partnership (TPP), threats to renegotiate or even pull out of the North American Free Trade Agreement (NAFTA), and a recently submitted plan to Congress that could unilaterally impose sanctions on countries the U.S. decides are engaging in unfair trade practices, experts, businesses and foreign governments alike are trying to guess the trade intentions of the America First administration.
In the midst of all the sturm und drang of economic nationalism has come the Congressional Republican plan of a Border Adjustment Tax (BAT). The idea of a BAT has been floated for some time within Republican circles and seems to have some support given the economic-nationalistic direction of the current administration. Some even see it as a middle, more respectable, course of correcting NAFTA or imposing tariffs on Mexican manufactured goods crossing the border to the U.S. market.
But what is it and what would its effects be on the region? Here we list three: 1) the impact of a rising dollar on country debt and currencies; 2) the interruption of U.S.-Mexico production chains; and 3) the World Trade Organization (WTO) sanctions the tax would likely trigger.
Quickly, and simply, BAT is a tax scheme in which corporations cannot deduct the costs of imports from their taxable income while profits from export sales are not taxed.
The incentive is to import less and export more. According to the Financial Times, in practice, “this would be equivalent to imports facing a tariff equivalent to the new corporate tax rate of 20 percent, while exports would be in effect subsidized.”
Who can be against that, right? Generally speaking, it sounds like a soft nudge—as they say in policymaking—for creating more local industry to replace imported goods and rewarding exports—all the while generating more revenue for the U.S. government. Win-Win, right??!!
No net money maker for the U.S. government
Except that there are several problems with it. First, as several have argued, the fiscal benefits are likely to be neutral; revenue gained from taxes on imports will likely be wiped out by not taxing revenue from exports. That would be OK, except for two reasons: 1) BAT is being justified to cut the corporate tax rate from 35 to 20 percent; and 2) some are floating it as a means to pay for President Trump’s Mexico-U.S. border wall, estimated to cost more than $20 billion dollars.
By no calculation will the BAT get you there, even under the most optimistic revenue-generating circumstances.
The rising dollar will hurt U.S. exports and allies hard
While there is some dispute over how long it would take the BAT to fully increase the value of the dollar, the general consensus is that the dollar would likely appreciate by 25 percent. As any university freshman economics student can tell you, that would have a devastating effect on the competitiveness of U.S. exports, no matter what incentives the U.S. tax structure provided State-side.
But the deeper effect would likely be felt by developing countries in the hemisphere, many of whom are closely tied—directly and indirectly—to the U.S. greenback. Nearly $10 trillion of the debt of countries outside the U.S. is tied to the dollar—so, as the dollar goes up, so does their debt. In the hemisphere that includes Jamaica and Venezuela, among others. (And while Venezuela is no ally of the U.S., the quickest way to push them over to that failed-state status that they’re already teetering on is to dramatically inflate their debt.)
Then there are the countries—El Salvador, Panama and Ecuador—that officially or unofficially use the dollar as their currency. Similarly affected are those countries that either have currency board or whose currencies are closely pegged to the dollar, which in our hemisphere include: Bahamas, Barbados, and Bermuda.
A major debt or currency crisis in any of these countries would bring economic upheaval and with it a serious dent on U.S. exports and financial sector—not to mention likely humanitarian outflow to the United States.
The unintended consequences of BAT would undermine the pro-U.S. gains of NAFTA
For all the other problems, perhaps the largest one for U.S. manufacturing and foreign relations would be the country this whole thing is supposed to punish: Mexico. The number that is always BATted around (pun intended) about U.S.-Mexico trade is that a manufactured product crosses back and forth across the border eight times before it is sold in the United States. In particular, those cross-border production changes affect automobile or aeronautical goods.
Far from being a solution to the Trumped-up allegations of manufactured goods flooding across the Mexican border to the United States that threaten U.S. jobs, BAT will create—at a minimum—a tax headache for U.S. manufacturers. Just taking the eight-border-crossing number for a moment, picture the poor beleaguered Boeing accountant adding the tax of an imported, semifinished turbine to the final product and then deducting it when it crossed the border again for another set of parts, and then adding the value-added back in when it crossed again with new parts.
So much for getting the state off the backs of U.S. producers. This sounds like a lobbyist/regulator/accountant’s wet dream—though hardly the reform that inspires actual entrepreneurs and businesses.
Oh yeah, and since it’s alleged to be at best a revenue neutral reform, BAT is not going to pay for that Wall.
And WTO retaliatory measures?
And then there are the retaliatory measures BAT would trigger under the World Trade Organization rules. Recently Nouriel Roubini estimated that those could cost up to $400 billion a year. Truth is, though, that’s pretty small change when you count the disruption the BAT would cause to the hyper-productive, efficient, cross-border production chains that have evolved out of basic market logic. In those cases, the real damage would be to U.S. productivity and GDP growth… and of course its reputation and moral authority.
BAT-er out? NAFTA should hope so.
Christopher Sabatini is editor of Latin America Goes Global and Lecturer of International and Public Policy at Columbia University’s School of International and Public Affairs. Originally published in Latin America Goes Global. Republished with permission from the author.