Demorest Law Firm is a member of the International Society of Primerus Law Firms, an international network of smaller law firms. Stewart & Stewart is our affiliated firm in Washington, DC, and they are experts in international trade issues. Terry Stewart of that firm graciously gave us permission to post his article.
During the campaign, now President-elect Trump identified a variety of actions that might be taken if he were President to address the nation’s trade deficit and hence restore manufacturing jobs at home. These include various actions (renegotiation, withdrawal) with regard to existing or negotiated but not yet implemented trade agreements, additional duties on imports from certain countries, increased pursuit of disputes with trading partners who are not fulfilling existing obligations, addressing currency manipulation, and strong enforcement of existing laws providing individual industries and their workers remedies for unfair trade practices.[1] These possible actions are in addition to infrastructure spending, modifications to corporate tax rates, review of regulatory burdens on industry, and other issues. Which, if any, of the above get implemented in 2017 will obviously be a matter of great interest to businesses, workers, and communities. Several items are receiving significant media attention at the moment and are addressed below.
First, during the summer of 2016, the Republican House leadership released a blueprint for tax reform[2] that included both a reduction in corporate tax rates (from 35% to 20%; President-elect Trump[3] has called for a reduction to 15%) and the adoption of an approach to corporate taxation that would add an aspect intended to mirror border adjustment-type systems which would result in taxes not applying to exports from the US but being applied to the full value of imports. Prior Administrations (going back to President Johnson) and prior Congresses have expressed concerns about the artificial challenges to US producers and their workers from GATT and now WTO rules which treat direct and indirect taxes differently, such that the United States, which relies primarily on direct taxes like income taxes are disadvantaged both on exports and in competing with imports from countries with indirect tax systems.[4]
While the incoming Trump team has not yet endorsed adoption of the House proposal and the Senate Finance Committee Democratic staff has raised concerns about possible WTO inconsistency,[5] some form of border adjustability provision is certainly one approach the incoming Administration could take to address the huge trade deficit in goods the nation runs.[6]
Second, the incoming Administration could opt to impose a balance of payment surcharge, similar to what President Nixon did in 1971 (when the US was shifting from a trade surplus to deficit for the first time in many years). 19 U.S.C. § 2132 gives the President the authority to proclaim a temporary import surcharge not to exceed 15 percent and/or temporary limitations through quotas on importation of articles into the US. The duration of any such action would be 150 days or less unless extended by Congress. The President may do so for various reasons including “to deal with large and serious United States balance-of-payment deficits”. 19 U.S.C. § 2132(a)(1).
A third approach is a variation of the balance of payment surcharge/quota approach and would be to adopt legislation to implement something akin to the Warren Buffett 2003 proposed plan[7] to issue import certificates equal to the value of US exports. Arguably, the President could implement this, for a period not exceeding 150 days, by proclamation under 19 U.S.C. § 2132.
Only the second approach could be taken quickly (subject to statutory requirements, consultations in the WTO, and possible legal challenge there).[8] The first approach (border adjustability) would likely be undertaken only as part of broader tax reform (including reduction of corporate tax rates from 35% to a rate in the 15-20% level) and would likely become law only – if at all – after protracted debate on the Hill. The third approach, like the second, has the advantage of flowing from concern about the massive trade deficit, could be adopted short term by the President, and would, if enacted into law, extend for a longer period (i.e., not be limited to 150 days), and would achieve balance quickly.
Parts of the business community have already come out against the House proposal on border adjustability (including, not surprisingly, the retailers/importers). While balance of payment actions can be taken to recognize different treatment for necessities from other goods, and border adjustments can be differentiated to reduce the potentially regressive effect of adjustments (at least in traditional VAT or GSM-type systems), one can expect opposition from many quarters if one or more of these options are pursued by the incoming Administration or the new Congress.
The purpose of this note is not to explore the pros and cons of any of the options outlined but rather to identify issues that companies, workers, and others should consider should it appear likely that one or more of the above options could be pursued and implemented. Any of the three options reviewed would likely present challenges and, for longer-term options, require rethinking business strategies, sourcing decisions, and manufacturing footprint.
Border adjustability
More than 180 countries and customs territories apply some type of value-added tax (VAT) to goods (some also apply such taxes to services). In 2013, the VAT rates applied to goods varied by country applying the rates and for different types of goods (with necessities such as food and medicines often at reduced tax rates). The VAT rate ran between 3% and 27% in 2013. Because the US does not have a value-added tax, US corporate tax rates tend to be higher than our trading partners, US exports typically get hit with the VAT upon entry into foreign countries, and foreign competitors are relieved of their VAT on export and don’t face imposition of a VAT in the US. So US producers are disadvantaged when exporting (i.e., no federal tax reductions from exportation but subject to additional taxes upon entry into foreign countries) and are also disadvantaged when facing competition from foreign product in the US market, as the foreign product is relieved of the indirect taxes from home and not hit with federal indirect (VAT-type) taxes upon importation into the US, nor charged with an equalizing direct tax. While economists argue that such disadvantages work themselves out over time by exchange rate movements, the theory of what should happen seems far removed from the reality of exchange rate movements in the 21st century.
A practical example would be the following: A US product sold in the US, fob plant, for $100 is shipped to Hungary with CIF charges and ordinary customs duty of 10% and gets hit with 27% VAT when entering, and so is available in Hungary for $139.70. The Hungarian product of comparable quality is sold at $100 plus VAT of 27%, or $127, and so is much preferred in Hungary because of the lower total cost.
The Republican proposal appears to be to make modifications to existing US income tax to make it more like a consumption tax (referred to in the Better Way proposal as more of a cash flow process vs. the introduction of a new tax). Key questions will be: (1) what level of tax found on exports will be rebated and what will be the level of border adjustment tax on imported goods; (2) whether there will be different levels of tax depending on type of good (e.g., lower or no tax rebates or assessments on necessities); and (3) whether the adjustment tax will apply to services as well as goods.
The US runs a massive trade deficit in goods ($762.565 billion in 2015; $735.170 in 2016 based on first ten months annualized) but runs a trade surplus in services ($262.203 billion in 2015; $245.307 billion in 2016 based on first ten months annualized). If all goods were subject to a rebate on export of 5% and all imports an assessment of 5% upon entry, US revenues would increase by $38.128 billion. If there were a 10% rebate on export and a 10% assessment on imports on goods, US revenues would increase by $76.256 billion. If services were included, because of the US surplus, the amount of increased revenue would decline by about one third.
For companies, obviously the introduction of a border adjustment could make their exports more competitive, reduce pricing pressures from imports, and make existing foreign sourcing options for inputs or finished products less competitive. How companies approach a review of these issues can affect both short and long-term success. Companies will need to consider how these issues impact various matters, including the availability of relevant capacity, their workforce, and raw materials, as well as the regaining of market share in the US and abroad, improved pricing, etc. Issues such as the terms of existing and future contracts where imports are used either as inputs or as final products may be important, particularly if there are fixed price agreements with no adjustments for border adjustments, etc. For workers and communities, an evaluation of likely plans of manufacturers and their potential need for workers and services could lead to targeted training, organization of community and state resources to facilitate any increases in production, etc.
Balance of payments
A presidential proclamation could be intended to be short term to gain the attention of our trading partners to the pressing need to address trade balance disequilibrium (whether deficits like in the US or surpluses of other countries) and obtain a consensus on a road forward through systemic changes or currency corrections, etc. President Nixon’s action in 1971 was temporary and led to agreement on currency realignment. At the same time, a presidential proclamation could be intended to be for a longer period (requiring Congressional extension) and focused more on obtaining correction of some, or all, of the imbalance through higher tariffs while the Administration and Congress work through other policy reforms/modifications or undertake negotiations to address the perceived causes of the ongoing massive imbalances.
For companies and workers, there is a need to identify perceived causes of the imbalance and provide information on such causes as input to the Administration and Congress as they consider how to address the imbalance legislatively and/or through negotiations. For companies, there are issues similar to those raised by border adjustability – export competitiveness, less pricing pressure from imports, sourcing issues where inputs or finished products are imported, contractual issues – but the issues are likely to be characterized by a changing dimension if relief is provided for a longer period and reduced over time. Because countries can exclude or apply a lower duty to some goods based on national needs, there is also the question of what type of system would be put in place and what goods would be given different treatment, if any. If a Buffett-type proposal were adopted and import certificates limited to the value of exports were issued, challenges for those sourcing offshore could vary based on access to certificates and approach to their distribution (e.g., if auctioned by the government, whether the system allocates to import categories or permits the possibility of categories of goods not acquiring any certificates).
While none of the above approaches may be pursued or, if pursued, become law or actually used, if the incoming Administration is intent on addressing the massive trade deficit in fact, some fairly significant change in the status quo will be required. Businesses will need to remain flexible and be prepared to identify best options for whatever course is adopted and implemented.
This article was written by Terry P. Stewart, Managing Partner of Stewart & Stewart.
[1] See generally David Francis, Trump’s Trade Agenda Would ‘Turn Back the Clock to Another Age‘, Dec. 22, 2016; http://foreignpolicy.com/2016/12/22/trumps-trade-agenda-would-turn-back-the-clock-to-another-age/.
[2] See A Better Way: Our Vision for a Confident America – Tax, June 24, 2016, http://abetterway.speaker.gov/_assets/pdf/ABetterWay-Tax-PolicyPaper.pdf. The border adjustment tax approach recommended by A Better Way is similar to one of the recommendations made in 2005 by the President’s Advisory Panel on Federal Tax Reform. See Simple, Fair, and Pro-Growth: Proposals to Fix America’s Tax System, Report of the President’s Advisory Panel on Federal Tax Reform, November 2005, https://www.treasury.gov/resource-center/tax-policy/Documents/Report-Fix-Tax-System-2005.pdf.
[3] See Trump Tax Plan, https://www.donaldjtrump.com/policies/tax-plan.
[4] For an historical review of the border adjustment issue, see Trade Lawyers Advisory Group, More Than 50 Years Of Trade Rule Discrimination On Taxation: How Trade With China Is Affected, August 2007; http://www.uscc.gov/Research/more-50-years-trade-rule-discrimination-taxation-how-trade-china-affected.
[5] The Democratic staff of the Senate Finance Committee issued a memorandum critiquing the House blueprint. See Problems with the Brady Blueprint, Democratic SFC staff memo, Dec. 8, 2016, http://taxprof.typepad.com/files/memo-1.pdf. See also Inside US Trade, Democratic Finance staff warns House GOP tax plan ‘possibly illegal’ at WTO, Dec. 16, 2016; https://insidetrade.com/daily-news/democratic-finance-staff-warns-house-gop-tax-plan-possibly-illegal-wto. (subscription required)
[6] Many articles have reviewed the potential interaction of the Trump tax plan and the House Republican’s tax blueprint. For a sampling, see Naomi Jagoda, Five questions for Trump’s tax reform, Forbes, Dec. 22, 2016, http://thehill.com/policy/finance/311096-five-questions-for-trumps-tax-reform; Inside US Trade, Report: Trump advisers considering early move to impose tariffs on imports, Dec. 22, 2016, https://insidetrade.com/trade/report-trump-advisers-considering-early-move-impose-tariffs-imports. (subscription required); Inside US Trade, Trump team: Too early to discuss House GOP border adjustability provision, import tariffs, Dec. 22, 2016, https://insidetrade.com/trade/trump-team-too-early-discuss-house-gop-border-adjustability-provision-import-tariffs. (subscription required); Inside US Trade, Brady: More tariff talk possible if House GOP tax reform fails; border adjustments to stay, Dec. 18, 2016, https://insidetrade.com/daily-news/brady-more-tariff-talk-possible-if-house-gop-tax-reform-fails-border-adjustments-stay. (subscription required); David Dayen, The GOP Is Ready for Tax Reform, but Tax Reform Is Hard, The Nation,Dec. 21, 2016, https://www.thenation.com/article/the-gop-is-ready-for-tax-reform-but-tax-reform-is-hard/.
[7] See Warren Buffett, Here’s How I Would Solve the Trade Problem, Nov. 2003 (Updated: Apr 30, 2016), Fortune.com, http://fortune.com/2016/04/29/warren-buffett-foreign-trade/. Articles regarding the Buffett plan include Robert E. Scott, Re-balancing U.S. trade and capital accounts: An analysis of Warren Buffett’s import certificate plan, EPI Working Paper # 286, December 2009, http://www.epi.org/publication/wp286/; Dimitri B. Papadimitriou, Greg Hannsgen, Gennaro Zezza, The Buffett Plan for Reducing the Trade Deficit, The Levy Economics Institute, Working Paper No. 538, July 2008, http://www.levyinstitute.org/pubs/wp_538.pdf; Dave Johnson, Balancing Trade – Remember The “Buffett Plan”, May 1, 2014; https://ourfuture.org/20140501/balancing-trade-remember-the-buffet-plan.
[8] For a review of WTO rules regarding actions addressing balance-of-payments difficulties, see Terence P. Stewart and Elizabeth J. Drake, Addressing Balance-of-Payments Difficulties Under World Trade Organization Rules, EPI Working Paper #288, December 2009, http://www.epi.org/files/page/-/pdf/wp288.pdf.
