Fraser Forum

Border tax—a possible threat to Canadian prosperity

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Forget $25-plus billion deficits in Ottawa. Forget a national debt now projected to grow to $1.5 trillion. Forget the competitive implications of a national carbon tax. Forget even the horrendous state of electricity prices in Ontario. The single greatest potential threat to the immediate economic well-being of Canadians is an obscure measure seriously being considered by congressional Republicans in the United States.

A Better Way” is a policy reform roadmap written by congressional Republicans. Among a host of desirable reforms, the plan calls for a reduction in the U.S. corporate income tax rate from 35 per cent, one of the highest in the industrialized world, to 20 per cent. Sounds great, but as is often the case the trouble exists in the details.

As part of the plan, the U.S. would introduce “border adjustability.” This policy would exempt U.S. exports from the corporate income tax but imports into the U.S. would no longer be deductible as business expenses.

For example, a U.S.-based firm exporting a product for sale overseas would no longer be subject to the domestic corporate income tax. However, if that same firm imports intermediate goods or raw materials to produce the final good, it would experience a 25 per cent increase in the cost of those inputs because it would no longer be able to deduct those costs as part of its production expenses. However, if that same firm shifted its production such that those same intermediate goods or raw materials were sourced domestically they would be deductible as expenses.

Simply put, the U.S. is considering an import tax, of sorts, that would make U.S. exports more profitable while at the same time making imports to the U.S. more expensive. To say such a policy could disrupt trade between Canada and the U.S. is to understate what could be a tectonic shift in production. A number of U.S. industries would be adversely affected if such a policy were implemented since they rely on Canadian inputs to create their products and it’s not clear that there are domestic substitutes readily available.

Consider for instance refiners in the Midwest that rely on Canadian crude from Alberta and Saskatchewan for processing. Those refiners are organized to process heavy crude, which is not produced domestically in the U.S. in any meaningful volumes. Or consider the homebuilding sector that relies on Canadian timber. Or the integrated auto-production and assembly industry concentrated along the I-75 corridor (Ontario to Alabama) where intermediate goods cross the border repeatedly before a finished good is completed.

The implications for Canadian producers affected are considerable and obvious—we would immediately experience a marked decline in our competitiveness.

Reports suggest that the advocates for the plan in Congress expect a rising U.S. dollar to mitigate the effects of the tax. In other words, the decline in the competitiveness of countries affected by the border tax would be at least partially offset by a rising U.S. dollar (and a declining foreign currency such as the Canadian dollar). Appreciation of the U.S. dollar would mean that imports would be relatively less expensive while U.S. exports would be relatively more expensive. However, there’s great folly and real risk to trying to mitigate a bad policy (border tax) through something Congress cannot directly control, namely currency valuations.
 
Thankfully reports suggest that President Trump is resistant to the proposal because of its complexity, which is significant. For instance, none of the reports to-date indicate that the border tax would adjust for previously imposed taxes. Intermediate goods in the auto sector, for instance cross the U.S.-Canadian border multiple times before a final good is produced. The border tax would have to include credits against previous taxes on imported goods lest the border tax compound on itself. The need for a credit system and thus more refined tracking of value-added production in each country would obviously complicate the administration of a border tax.

Let’s hope saner heads prevail as the powers in Washington, D.C. begin negotiations on the budget, trade and tax reform. At the same time, Canadians should demand strong and well-informed representation by their political leaders. Relying solely on Americans to consider Canadian prosperity and economic well-being would be a dereliction of duty on the part of Canadian leaders.

 

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