The common wisdom in Washington these days is that the Border Adjustment Tax (BAT) is in trouble because of opposition from retailers who collectively account for 29 million jobs, of which 11.5 million jobs are provided by small business (those employers with less than 50 employees). The argument is further made that since a putative 20% BAT would produce a large part of the revenue necessary to finance a corporate tax cut, that part of the GOP economic plan would also be in jeopardy.
BAT as a Blunt Instrument
The problem with most versions of the BAT is that it is a blunt instrument with too many objectives to be used in a world where other countries can be, and often are, surgical in their approach to trade. This blunt instrument could make life more difficult for millions of lower income Americans who rely on inexpensive imports for their clothes and many other necessities of life, as well as retailers disproportionately dependent upon imports, such as Wal-Mart (NYSE:WMT). Furthermore, it could distort sound economic concepts such as comparative advantage which have led to growth and better lives worldwide since World War 2. It would be far better if we focus on only one objective for the BAT tool - promoting American exports and jobs. We need to design an instrument to be focused upon that without a myriad of supplemental objectives. In order to do that, we need to focus more clearly on the problem.
In 2016, the total U.S. trade deficit was $502 billion ($2.712 trillion in imports vs. $2.209 trillion in exports). Of this sum, five countries in 2016 (China $347B; Japan $69B; Germany $65B; and Mexico $63B) accounted for $544B, which is more than the total deficit. However since Germany is part of the European Union, we have to treat them as part of one trade block. So substituting the EU's deficit of $91B for Germany's deficit, the total deficit with the above five entities becomes $570B, or 14% more than the entire U.S. deficit with all 190 plus sovereign countries in the world. One implication is that we could, therefore, design a simple system which addressed the problem we have with the above Big 5 trade deficit countries, and pretty much solve our entire problem without needing to make more than some minor adjustments for the other 180+ countries.
A Modest Proposal
My proposal is that Congress pass a Border Adjustability Tax with a wide range. The word "Adjustability" implies that it might be adjusted for different conditions, whereas "Adjustment" might imply a one-size-fits-all single adjustment. The main argument for a border tax is that the Value Added Tax (VAT) refund on exports used by many countries, and the lower corporate tax rates around the world, lead to an unfair trade advantage against the U.S. However, that is not the whole story. While the U.S. does not have a national VAT (which operates much like a sales tax, but is applied to the value added at each stage in the product value chain), high sales taxes in many states like California act in like fashion since sales taxes are only applied to the final consumer sale, and not to products exported. Likewise, the advantage to the final export price of a lower corporate income tax rate is likewise difficult to calculate since it depends on the gross margin and final before tax profit of each intermediary in the value chain. To calculate the exact advantage that each trade partner derives from different policy choices would require a Soviet-like bureaucracy operating something like a Leontief input-output model for the whole world; in other words, not really practical or worth doing.
Setting the Upper and Lower Bounds of the BAT
Instead of trying to accomplish the impossible task of creating a world input-output model, it would be much simpler and better to adopt a flexible BAT which gives the Administration discretion to set or negotiate import taxes within a broad range. The lower bound should be set at 1-2% (or even zero) for countries with which we do not have a trade problem.
The upper bound could be 20% to be theoretically applied to the countries with which we have the largest trade deficits. However, I would not expect this rate to actually be paid by anyone. It would be the ultimate hammer to use in the bilateral negotiations we would have with the 5 countries/entities with which we have the highest absolute trade deficits. We would say, for example, to the EU: "We have a $91B trade deficit with you, which we feel is unfair and much too high. We would apply a 5% initial BAT to you (which would be very easy to justify given European levels of VAT and corporate income taxes). We want you to agree to a deficit glide path to cut your trade deficit by perhaps 70% over a reasonable adjustment period (say 6 years); and we would keep the BAT at 5%, or even less, if you stay on or overachieve the objectives of the agreed glide path. If you exceed your deficit, however, we will have to steadily increase your BAT to 20% over a number of years."
What About Retaliation from Trade Partners?
It would be very unlikely that there would be any retaliation from anyone. If our trading partners imposed measures to cut their U.S. imports, they would only be giving themselves a "tougher row to hoe" to achieve the desired cut in their trade surplus with us. In fact, the only rational response on the part of large trade surplus countries would be to increase their imports from the U.S. I would foresee a large increase in the number of purchasing missions visiting this country after the passage of such a BAT. To paraphrase Teddy Roosevelt, our chief trade negotiator would henceforth "Speak softly, but carry a big BAT".
What About WTO Issues?
The first thing to realize about the World Trade Organization is that it is an organization of 600 plus international bureaucrats in Switzerland enforcing international trade rules designed for a free trade, free market world which no longer exists (if it ever did). It is ill-equipped to deal with neo-mercantilist control economies which can suddenly shutdown their tourism to a targeted country; find excuses to shut down local supermarket chains owned by a parent company in the another country; boycott their pop singers; ban bathroom appliances; or launch a nationwide attack over state television on the reputation of a company for mistakenly selling 300 pairs of their Hyperdunk 2008 FTB sneakers without the advertised "Zoom Air sole cushion" (apparently even after the company made offers to fully compensate affected customers). All of the above manifestly unfair trade tactics were either imposed for political purposes or to benefit favored local competitors - all without even a peep from the WTO. We are not really saying that the WTO could or should do very much in each of the above cases, but we do say that a country like the United States can no longer conduct itself as if it lived in an ideal world of its own creation without recognizing how other major players in the system actually operate. In any case, I doubt very much that the WTO will have much to say about bilaterally negotiated individual trade agreements.
There are a number of economics professors who would argue that the reason the U.S. trade deficit is so high is that the U.S. national savings rate is so low. While it is a standard definition in economics that the trade deficit (imports of goods and services minus the exports of goods and services) is of necessity equal to national savings minus national investment, this identity is in no way predictive. The national savings rate is composed of individual savings plus corporate savings. Individual savings are low because interest rates are near zero for risk-free instruments like T-bills or bank deposits. Corporate savings are low because investment opportunities are low in our low-growth economy. Hence, many corporations find it more beneficial to their shareholders to pay higher dividends (going largely to more consumption) or buy back shares. An increase in export demand produced by a well-designed BAT would increase investment opportunities in the U.S. leading to both higher interest rates for savers (hence higher savings) and more investment of retained profits by U.S. corporations.
What About Financing the Corporate Tax Cut?
It is not in the scope of this present article to present alternative sources for financing a corporate tax cut, or of more dynamic econometric modeling by the Congressional Budget Office. However, a simpler BAT which achieved the objective of increasing U.S. exports might be worth the tradeoff of a smaller corporate tax cut.
The flexible BAT in the hands of a skilled negotiator could lead to an outcome with many U.S. winners, and very few losers. Chief among the winners would be major U.S. exporters such as the aerospace industry and participants such as Boeing (NYSE:BA), Honeywell (NYSE:HON), and United Technologies (NYSE:UTX); as well as producers of major capital equipment and machinery necessary for the re-industrialization of the country such as General Electric (NYSE:GE), Caterpillar (NYSE:CAT) and many others. Most other industries also would benefit from the pick-up in general economic activity brought about by an export-led re-industrialization effort.
In the post-WW2 world economy, the U.S. could afford to be very magnanimous in its various trade policies which achieved great success in raising living standards around the world, and which helped many war-devastated countries to rebuild. In the current world where we have many economic peers, and where the U.S. manufacturing economy is being steadily "hollowed out", a fairer system tailed to specific problems is definitely called for.
Disclosure: I am/we are long UTX, GE, HON, QCOM.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.