Beware the new US ‘border tax’ plan

A NEW and deadly form of protectionism is being considered by US leaders, and it could have devastating effects on the exports and investments of developing countries like Malaysia, as well as destabilising the world economy.

The plan, known as a border adjustment tax, would have the effect of taxing imports of goods and services that enter the United States, while also providing a subsidy for US exports which would be exempted from the tax.

The proponents’ aim is to drastically reduce imports while promoting exports, and thus reduce the huge trade deficit in the United States. It fits in with US President Donald Trump’s goals to make America great again, to buy American and hire Americans.

On the other hand, if adopted, it would depress the competitiveness or viability of other countries’ goods. The prices of their exports to the United States will have to rise due to the tax effect, depressing their demand and, in the worst case, making them unsaleable.

And companies from the United States that invested in developing countries because of cheaper costs and then export to the United States may find their business affected because their products will cost more.

Some will think of relocating back to the United States, and investors will be discouraged from opening new factories in developing countries.

The border adjustment tax is part of a tax reform bill being drafted by the Republican Party, with Paul Ryan, the speaker of the House of Representatives, being the chief advocate.

Trump originally criticised the plan for being “too complicated” but is reportedly now considering it seriously. The proposal has generated tremendous controversy in the United States, but also enjoys strong support and some version is expected to be tabled.

Originally, Trump favoured the simple imposition of a tariff on products from selected countries, especially China and Mexico. But it is too blatantly protectionist and would surely trigger swift retaliation.

The tax works like this. Firstly, as part of the overhaul of the corporate tax system, the expenses of a company on imported goods and services can no longer be deducted from a company’s taxable income.

The corporate tax rate would be reduced from the present 35% to 20%. The effect is that a 20% tax would be applied to the companies’ imports.

On the other hand, the new plan allows a firm to deduct revenue from its exports from its taxable income. This would allow the firm to increase its after-tax profit.

At the macro level, with imports reduced and exports increased, the United States can cut its trade deficit, which is a major aim of the plan.

The United States is a major export market for many developing countries. It is Malaysia’s third largest export market, in 2016 accounting for RM80bil or 10% of total exports.

An equivalent of 20% tax on these products may render some firms that use or sell them less profitable; and if the prices are forced upwards they may lose competitiveness to substitute products or similar locally made products.

American industrial companies are also investors in many developing countries. The tax plan, if implemented, would reduce the incentives for some of these companies for being located abroad as the parent company can no longer claim tax deductions for the goods imported from their subsidiary companies overseas.

According to a report in The Star (Feb 6, 2017), speculation on industries relocating to the United States is sparking concerns in Malaysia. Major US factories in Malaysia producing electronics would be under watch.

Also, electronic and electrical as well as garment companies in Malaysia, which are mainly sub-contractors for multinational companies, may be affected should they decide to bring back manufacturing jobs to the United States.

The plan is bound to generate outrage from its trading partners in both South and North. They may take cases against the United States at the World Trade Organisation, which is likely to rule against the Americans.

The new tax deduction system discriminates against imports, thus violating the WTO rules of non-discrimination.

The exemption of income tax for export sales would most likely be assessed as an export subsidy prohibited by the WTO subsidy agreement.

However, it can take three to four years for a case in the WTO to be finally settled. Meanwhile, the United States can continue with its laws and practices and reap the benefits.

Another possibility is that Trump may make good his threat to leave the WTO if important cases go against it. That would cause a major crisis for multilateral trade.

There are many critics of the plan. Larry Summers, a former US Treasury Secretary, warns that the tax change will worsen inequality, place punitive burdens on import-intensive sectors and companies, and harm the global economy.

The tax plan is expected to cause a 15-20% rise in the US dollar. “This would do huge damage to dollar debtors all over the world and provoke financial crises in some emerging markets,” according to Summers.

US retail companies like Walmart are strongly against it, and an influential Republican, Steven Forbes, owner of Forbes magazine, has called the plan “insane”.

It is not yet clear what Trump’s final position will be. If he finds it too difficult to use, because of the effect on some American companies and sectors, he might opt for the simpler use of tariffs.

In any case, whether tariffs or border taxes, policy makers and companies and employees in developing countries should pay attention to the trade policies being cooked up in Washington and voice their opinions.

Otherwise they may wake up to a world where their products are blocked from the United States, the world’s largest market, and where the companies that were once so happy to make money in their countries suddenly pack up and return home.

Martin Khor (director@south is executive director of the South Centre. The views expressed here are entirely his own.

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