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SOUTH BULLETIN Published by the South Centre ● www.southcentre.int ● 17 March 2017, Issue 98 A new protectionist threat: the US "border adjustment" tax A new protectionist device, the US “border adjustment” tax, is being planned that could devastate the exports of developing countries and cause American and other for- eign companies to relocate. The Chip Somodevilla/Getty Images first article explains the complexi- ties and implications of this propo- sed measure. The major question of whether such a measure will vio- late the rules of the WTO is exam- ined in the second article. Launch of the tax proposal “A better way” at the US Congress by Paul Ryan, speaker of the House of Represent- Pages 2-7 atives. Border tax proposal, WTO South Centre Brief- rules and how developing ing on Global Eco- countries could respond nomic Trends and Geneva Multilateral Pages 8-9 Processes Some simple criteria for examin- Pages 10-14 ing WTO compatibility of certain South Centre and Indonesia hold policies and measures Page 9 inaugural forum for South-South cooperation on tax Challenges and policy issues Opportunities Pages 17-20 for the Next South Centre co-organises retreat WHO Director- for governments on Financing for General Development in New York Pages 15-16 Pages 21-22 Beware of the new US protectionist plan, the border adjustment tax A new protectionist device is being planned in the United States The plan is a key part of the Ameri- that could devastate the exports of developing countries and ca First strategy of US President Don- ald Trump, with his subsidiary policies cause American and other foreign companies to relocate. The of “Buy American” and “Hire Ameri- complexities and implications of the proposed border adjust- cans.” ment tax are explained in this article. This is the first of a two The border adjustment tax is part of part series on the US border tax plan. a tax reform blueprint “A Better Way” whose chief advocates are Republican leaders Paul Ryan, speaker of the House of Representatives and Kevin Brady, Chairman of the House Ways and Means Committee. President Trump originally called the plan “too complicated” but is now considering it seriously. In a recent address to congressional Republicans, Trump said: “We’re working on a tax reform bill that will reduce our trade deficits, increase American exports and AP Photo/ZachAP Gibson will generate revenue from Mexico that will pay for the (border) wall.” The proposal has however generat- ed a tremendous controversy in the US, with opposition coming from some Congress members (including Republi- cans), many economists and American companies whose business is import- intensive. The border adjustment tax is part of a tax reform blueprint “A Better Way” whose chief advocates are Republican leaders Kevin Brady, Chairman of the House Ways and Means Committee (left), and Paul It however has the strong support of Ryan, speaker of the House of Representatives (right). Republican Congress leaders and some version of it could be tabled as a bill. By Martin Khor On the other hand, if adopted, it Whether it will be passed remains to be would significantly reduce the com- seen. new and deadly form of protec- petitiveness or viability of goods and A tionism is being considered by services of countries presently export- Trump had earlier threatened to Congress leaders and the President of ing to the US. The prices of these impose high tariffs on imports from the United States that could have dev- exports will have to rise due to the countries having a trade surplus with astating effect on the exports and in- tax effect, depressing their demand the US, especially China and Mexico. vestments of American trading part- and in some cases make them unsala- This might be a more simple meas- ners, especially the developing coun- ble. tries. ure, but is so blatantly protectionist And companies from the US or that it will trigger swift retaliation, and The plan, known as a border adjust- other countries that have invested in would almost certainly be found to ment tax, would have the effect of tax- developing countries because of violate the rules of the World Trade ing imports of goods and services that cheaper costs and then export their Organization. enter the United States, while also products to the US will be adversely providing a subsidy for US exports The tax adjustment plan may have a affected because of the new US im- similar effect in discouraging imports which would be exempted from the port tax. tax. and moreover would promote exports, Some firms will relocate to the US. but it is more complex and thus diffi- The aim is to improve the competi- Potential investors will be discour- cult to understand. tiveness of US products, drastically aged from opening new factories in The advocates hope that because of reduce the country’s imports while the developing countries. In fact this the complexity and confusion, the promoting its exports, and thus narrow is one of the main aims of the plan – the huge US trade deficit. measure may not attract such a strong to get companies to return to the US. response from US trading partners. Page 2 ● South Bulletin ● Issue 98, 17 March 2017 ports cannot be deduct- Under the new plan, the export ed and would form part sales of $10,000 is exempt from tax, so of the new taxable total the company has zero tax. Its profit of $8,000. With a 20% after tax is thus $3,000. The company tax rate, the tax would can cut its export prices, demand for be $1,600 and the after- its product increases and the company tax profit $1,400. can expand its sales and export reve- nues. Given this scenario, if the company wants to At the macro level, with imports retain his profit margin, reduced and exports increased, the US it would have to raise its can cut its trade deficit, which is a ma- price and revenue sig- jor aim of the plan. nificantly, but this in On the other hand, the US is a ma- turn would reduce the jor export market for many develop- volume of demand for ing countries, so the tax plan if imple- the imported goods. mented will have serious adverse ef- For firms that are more fects on them. import-dependent, or The countries range from China with lower profit mar- and Mexico, which sell hundreds of gin, the situation may billions of dollars of manufactured be even more dire, as products to the US; to Brazil and Ar- some may not be finan- gentina which are major agricultural cially viable anymore. exporters; to Malaysia, Indonesia and Take the example of a Vietnam which sell commodities like company with $10,000 palm oil and timber and also manufac- The report, “A better way,” produced in June 2016, is now the sub- revenue, $7,000 imports, tured goods such as electronic prod- ject of intense discussion in Congress and in the public. It is not clear $2,000 wages and $1,000 ucts and components and textiles; Ar- whether it will be adopted by Congress. profit. With the new ab countries that export oil; and Afri- Moreover they claim it is permitted by plan, the taxable total is $8,000 and the can countries that export oil, minerals the WTO and are presumably willing tax is $1,600, so after tax it has a loss of and other commodities; and countries to put it to the test. $600 instead of a profit of $1,000. like India which provide services such as call services and accountancy ser- The company, to stay alive, would In the tax reform plan, the corporate vices to US companies. tax rate would be reduced from the have to raise its prices very significant- present 35% to 20%. The border ad- ly, but that might make its imported American industrial companies are justment aspect of the plan has two product much less competitive. In the also investors in many developing main components. Firstly, the expenses worst case, it would close, and the im- countries. The tax plan if implemented of a company on imported goods and ports would cease. would reduce the incentives for some of these companies to be located services can no longer be deducted The economist Larry Summers, a abroad as the low-cost advantage of from a company’s taxable income. former Treasury Secretary, gives a sim- the foreign countries would be offset Wages and domestically produced in- ilar example of a retailer who imports by the inability of the parent company puts purchased by the company can be goods for 60 cents, incurs 30 cents in to claim tax deductions for the goods deducted. labour and interest costs and then imported from their subsidiary com- earns a 5 cent margin. With 20% tax, The effect is that a 20% tax would be panies abroad. applied to the companies’ imports. and no ability to deduct import or in- terest costs, the taxes will substantially Perhaps the most vulnerable coun- This would especially hit companies exceed 100% of profits even if there is try is Mexico, where many factories that rely on imports such as automo- some offset from a stronger dollar. were established to take advantage of biles, electronic products, clothing, toys tariff-free entry to the US market un- On the other hand, the new plan and the retail and oil refining sectors. der the North American Free Trade allows a firm to deduct revenue from Agreement. President Trump has The Wall Street Journal gives the its exports from its taxable income.

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