Fraser Forum

Trump border tax plan may harm Canadian-based companies

Printer-friendly version

The new U.S. administration under President-elect Donald Trump is set to assume office on January 20. The hiatus between the election and pending inauguration of the new president has not resulted in a great deal of clarity surrounding Trump’s policy priorities. While major reforms, if not a complete repeal, of President Obama’s signature Affordable Care Act seem likely to be an early policy focus, of more immediate concern to Canadians are forthcoming trade policy initiatives that will affect the bilateral trade and investment regime.

At this point in time, President-elect Trump’s campaign pledge to renegotiate NAFTA remains vague in terms of both its timing and its precise focus. What does appear to be a relatively high priority initiative increasingly discussed by Trump advisors is the imposition of a so-called border adjustment tax plan. This tax change might or might not be part of a broader corporate tax reform effort, but it’s clearly meant to address what the Trump team believes is an unfair tax disadvantage confronting U.S.-based companies.

Most trading partners of the U.S., including Canada, employ some sort of national consumption-based value added tax (VAT) whereas the U.S. does not. The VAT is border adjustable. For example, a Mexican-made car sold in Mexico will carry the VAT, as will a car that is imported into Mexico from, say, the U.S. However, the VAT will be rebated to the purchaser if the car is exported from Mexico.

Conversely, a U.S.-made car is treated identically for tax purposes whether the car is sold in the U.S. or sold outside the U.S. While there are other differences in national tax systems that are causes for concern to the incoming administration, Trump’s economic advisors see this “destination-based” tax arrangement as systematically disadvantaging U.S. exports while encouraging U.S. imports. The border adjustment tax proposal being discussed by the Trump team would exempt exports from the corporate income tax while it would tax U.S. imports at the corporate income tax rate. This would make the U.S. tax system more sensitive to where goods end up rather than on where they are produced.

The immediate effect of implementing the border adjustment tax plan would make it more expensive for U.S. companies to import products from its trading partners including Canada. It would also make it more profitable, on the margin, for U.S. companies to export to countries such as Canada, as compared to selling products in the U.S. Hence, Canadian companies might find it necessary to lower their export and domestic prices or face losses of sales in both the U.S. and in their domestic market. Given the prominence of the U.S. as a trading partner for Canada, the proposed tax change might have a substantial impact on the trade competitiveness of Canadian-based companies.

At the same time, the practical significance of the proposed tax change is far from clear. For one thing, the U.S. proposal, if implemented, is likely to be challenged by a number of countries at the WTO. This is because tax exemptions on exports are illegal under WTO rules unless they are consumption-based taxes such as a VAT. For another thing, any boost to U.S. net exports encouraged by the proposed tax change would put upward pressure on the U.S. dollar, other things constant, which would mitigate the trade advantages for the U.S. created by the tax change.

What is clear is that the potential for significant direct and indirect changes to U.S. trade-related policies is creating substantial uncertainty for companies based in the U.S. and in its trading partners, particularly large trading partners such as Canada and Mexico. This uncertainty will discourage capital investment, which is critical to both a recovery in productivity growth and to faster economic growth in North America more generally.

Subscribe to the Fraser Institute

Get the latest news from the Fraser Institute on the latest research studies, news and events.