Will Trump’s tough talk on trade or the Republican-proposed border adjustment tax (BAT) to pay for U.S. corporate tax rate cuts reverse the trend toward greater global economic integration and higher trade volumes? The answer depends in part on: (1) how closely trade and tariffs are related, (2) how large and broad-based proposed tariff increases are, and most importantly, (3) whether talk about raising tariffs translates into action. We are skeptical on all three counts.
First, although U.S. tariffs came down dramatically during World War II, they have declined only slowly since, in part because they had been negotiated down to about 15 percent by the end of the war.1 Since 1980, U.S. tariffs have moved down into the low-single digits while global tariffs have fallen from 10 – 12 percent to 6 – 9 percent depending on the tariff series. Recent declines in tariffs are due to increasing WTO membership and the proliferation of free trade agreements among WTO members — many are bilateral.
It is worth noting that U.S. tariffs are among the lowest in the world and currently average about 3 percent. U.S. tariff levels suggest that the United States is among the most open economies in the world (Chart).
The House Republican-proposed BAT would impose a de facto 20 percent tax on U.S. imports by eliminating the deductibility of imports as a business expense for corporate tax purposes. Thus, while not technically a tariff because it is administered through the corporate income tax system rather than imposed at the U.S. border, it operates like a transactions tax for accessing the U.S. market. To gauge the magnitude of this tax in a trade context, a 20 percent import tax would be three times higher than prevailing international tariff rates and almost seven times higher than U.S. tariffs currently.
The House proposal is opposed by both the U.S. Senate and the Trump administration not only because they object to it as a tax policy, but also because it establishes a cost to accessing U.S. markets, which, in practical terms, there hasn’t been seen since World War II.2 U.S. importers and manufacturers with large global supply chains would bear a disproportionate burden of a BAT. Already, trading partners like the European Union have signaled that they will fight a BAT in the WTO.
Moreover, the broad sweep of U.S. economic history shows that high tariffs are not sustainable over time with the resulting tariff-based federal revenue ultimately replaced by non-tariff revenue. A BAT would likely succumb to the same fate. Nevertheless, the BAT is likely to remain in the tax reform mix until an acceptable alternative to offset tax reform’s deficit effects is found.
1 United States International Trade Commission. “The Economic Effects of Significant U.S. Import Restraints.” August 2009: 64. www.usitc.gov. Web.
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