There are a lot of problems with Trump’s 20% border tax idea

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President Donald Trump Drew Angerer/Getty Images
  • The tax could come in a broader tax reform bill and would be used to help pay for a border wall
  • However, American consumers and companies may end up actually paying the tax
  • The tax might not improve the US trade deficit as other countries respond

On Thursday, President Donald Trump and his administration debuted a series of new economic talking points on trade.

Trump, in a speech to Republican lawmakers in Philadelphia called for a change in the tax code to reduce trade deficits.

“We’re working on a tax reform bill that will reduce our trade deficits, increase American exports and will generate revenue from Mexico that will pay for the wall if we decide to go that route,” said Trump.

White House press secretary Sean Spicer then followed this up with comments suggesting that the Trump administration is considering a 20% tax on imports, starting with Mexico, that would help finance the building of a border wall between the US and Mexico.

“When you look at the plan that’s taking shape now, using comprehensive tax reform as a means to tax imports from countries that we have a trade deficit from, like Mexico,” said Spicer. “If you tax that $50 billion at 20 per cent of imports — which is by the way a practice that 160 other countries do — right now our country’s policy is to tax exports and let imports flow freely in, which is ridiculous.”

While Spicer later clarified that this was one of many options being looked at to pay for the wall, the suggestion set off a firestorm of attention.

The only problem is that Trump’s, and later Spicer’s, comments paint the picture of an unfocused plan that could do more harm than good if implemented.

For one thing, not everyone is sure exactly what Spicer meant when he was describing his “border tax.” Most economic observers took Spicer’s language, especially citing the trade deficit, or the difference in imports from and exports to Mexico, and not just raw imports, to mean a border adjustment tax. This is an idea favoured by many congressional GOP leaders, but one Trump had previously described as “too complicated.”

According to the Washington Post, some Republican lawmakers assumed Trump and Spicer meant a border adjustment tax, but many GOP staffers were unclear on whether that was the case due to Trump and Spicer’s vague language.

Spicer, however, did not clarify the comments in a later meeting with reporters and said that the tax was just one possible “option” for making Mexico pay for the wall.

For an economic perspective, let’s assume Spicer was talking about a border adjustment tax or BAT.

Spicer’s insistence that a border tax would mean that Mexico is “paying for the wall” is hardly correct. While barriers to exporting would certainly hurt the Mexican economy, the actual people footing the bill would be in the US.

Since a BAT is paid for by companies selling goods in the US, these companies would have to either eat the new tax (which is unlikely) or pass the cost onto consumers in the form of higher prices to protect profit margins. Thus, US consumers would end up paying higher prices to fund the tax, not Mexico.

Additionally, since a BAT is a tax on consumption in the US, it would be difficult to have it target one country, such as Mexico. This would imply Spicer was talking about a tariff, since those are more simple to make country-specific.

Republican lawmakers argue that the BAT would offset the price increase since the shift in the trade balance would cause the dollar to strengthen, improving the purchasing power of Americans and scaling back the effect on consumers. A stronger dollar, however, is also consistently the top complaint of S&P 500 companies when they report quarterly earnings, as it makes American-made goods and services less attractive to customers overseas.

The other problem with the GOP proposal is it allows companies to subtract the cost of labour and land, as well as input goods, from the amount that gets taxed.

Economic analysts have suggested that this may violate World Trade Organisation standards as it not only incentivizes exports, as many countries’ value added tax systems do, but also incentivizes domestic production. Additionally, retaliatory measures from other countries could spark a trade war.

Furthermore, economists seem to think this proposal would cause problems for the US economy.

Michael Gapen, chief economist at Barclays, said the border tax would decrease GDP and compared it to Japan’s experience with a value-added tax. From Gapen’s note to clients:

“We estimate that a 20% border tax could increase year-over-year rates of core inflation by 0.5-1.0 percentage points and reduce real GDP growth by 1.0-1.5 percentage points. Japan, which raised its VAT by 3pp in 2014, provides a useful case study for comparison. The response of inflation in Japan was consistent with what we would expect for the US. However, the decline in GDP growth was much larger at 4pp (to -1.1% y/y from 3.1% prior to the increase in the VAT), implying significant downside risk to our estimates.”

Additionally, Ethan Harris, chief US economist at Bank of America Merril Lynch, noted a BAT may not even decrease the size of the trade imbalance.

“Imposing tariffs, border adjustment taxes, or other protectionist measures will only reduce gross trade flows, without necessarily reducing the US deficit because, as we mentioned above, trade deficits are related to the inter-temporal consumption decision of a country rather than to trade agreements,” wrote Harris in a note to clients.

Put another way, countries that see the price of imports go up may simply choose to export elsewhere rather than to the US and also decide not to accept as many US exports. So the impact may be a wash in terms of trade deficits.

Not only that, but many industries that depend on imports have some out against the plan and Goldman Sachs estimated that American companies from Nike to Walmart to Restoration Hardware will see their businesses negatively effected by such a tax.

The fact of the matter is that it is not clear what Trump and Spicer want out of a border tax. Between the muddled messaging and the unclear implications of different policies, the Trump team has a ways to go before they have developed a fully formed trade policy to benefit Americans.

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