For 20 years running, the United States’ current account deficit with the world has resided in the neighborhood of $500 billion per year. Every year, America receives $500 billion less for its exports than it pays for imports.
In the short run, the trade imbalance doesn’t matter much. The United States is nicely buoyed by the purchase of Treasuries by world central banks.
But over a longer period of time, such a payments deficit is dangerous.
Enter the border-tax debate.
President Trump envisions a border tax levied against any American company that has moved its operation overseas.
A congressional majority also wants a border tax, so we’re likely to get one soon.
But would a border tax truly solve America’s lopsided trade problem?
Or would it spark a global trade war worse than the 1930s?
The “Differential” Conundrum…
President Trump is right in one respect — America operates at a decided disadvantage in international trading thanks to a value-added tax (VAT) enjoyed by most other countries.
VATs operate much like a sales tax — only they typically run at 20% or higher.
Here’s how a VAT works…
Say an American company exports something to France.
A person in France who buys the good must pay a 20% VAT on top of the purchase price.
Conversely, when a French company sells into the United States, the U.S. buyer pays only the purchase price plus a modest sales tax in the 5–8% range — but he/she never pays a VAT.
Did you catch what just happened?
The 12–15% differential between the tax on a U.S. export to France and French imports to the United States puts Uncle Sam behind the eight ball.
Although the press never covers the differential, it functions much like a 12–15% tariff on U.S. goods.
Yet under World Trade Organization (WTO) rules, the practice is perfectly legal.
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Of course, if America unilaterally imposed a 12–15% tariff to close the differential, its actions would spark a trade war. And history from the last trade war — during the 1930s — tells us that the entire world economy would suffer.
However, some type of American VAT — call it a border tax, if you will — could effectively close the differential while also keeping the global economic engine humming.
Trump Could Spark a Trade War…
The simplest way to close the differential would be for the United States to impose its own VAT on every good sold in the country — whether the good is imported or produced at home.
A 10% VAT on all goods sold would yield huge amounts of revenue — perhaps $1 trillion per year — thus solving Uncle Sam’s budget deficit problem. Yet it would also raise the price Americans pay at the cash register by 10%. Yikes!
Needless to say a Republican House that raises taxes to this extent would almost certainly lose the midterm elections in a landslide.
President Trump wants to impose a HUGE tariff of 35% on a few countries, notably China. He also wants to tax U.S. companies that outsource production and sell back into the country.
Such a plan, however, would break existing trade rules.
Of course, the president won the White House by calling many of our international policies “stupid.”
Put simply, don’t be surprised if Trump directly challenges the WTO’s authority as the overseer of global trade.
Either way, some kind of border tax is likely in our future.
Let’s just hope Trump clears it with the WTO first.
Otherwise, retaliations will kill world trade.
Senior analyst, Wall Street Daily