The Unintended Consequences Of Trump's 35 Percent Import Tax Proposal

In a high-profile announcement in Indiana last week, Donald Trump and Mike Pence celebrated that air-conditioning and furnace manufacturing company, Carrier, would not be shipping 1,100 jobs to Mexico after all; an announcement carefully staged to provide a congratulatory photo-op to Team Trump for saving American jobs, even before the new administration takes office.

It's good news for those whose jobs were saved. But Trump immediately received criticism for the deal, which offered tax breaks to save those jobs. Even the likes of Sarah Palin, a Trump advocate, weighed in and said the arrangement was both picking winners and crony capitalism.

Perhaps as a counter-punch to this criticism, or perhaps because Trump realized the Carrier deal might set a dangerous precedent for other firms looking for a similar tax break to stay put, the president elect took to Twitter over the weekend to assert a much more stern position:

“The US is going to substantially reduce taxes and regulations on businesses, but any business that leaves our country for another country, fires its employees, builds a new factory or plant in the other country, and thinks it will sell its product back into the US without retribution or consequence, is WRONG! There will be a tax on our soon to be strong border of 35% for these companies wanting to sell their product….” back into the U.S., Trump tweeted.

Prior to this Twitter onslaught, many other firms probably thought it might be worth negotiating tax breaks with the president elect to get a piece of the action. And why not? Under the terms of the Carrier deal, it appears the state of Indiana -- whose governor is still Mike Pence -- offered the company $7 million in tax breaks over 10 years in order to save what was actually 800 jobs. Likely, more was promised besides and so it was tax incentives -- rather than a big stick -- that saved those jobs. Despite picking up some favorable reviews over the job retention, Trump probably decided he needed to turn up the heat to head off would-be copycat deals.

And a 35 percent tax on imported goods certainly would turn up the heat. It may also give pause to companies deciding where to produce their wares, as Trump intends. But if the tax is implemented, would it actually work? And what about the unintended consequences?

Incidentally, before we dive into this, while Trump talks about a 35 percent tax at the border, he presumably means a 35 percent import tariff. During the election season, Trump made a big deal of the notion that America is being ripped off by other countries over trade arrangements. For example, he claimed that while China slaps tariffs on U.S.-made products, the United States does not reciprocate on imports from China.

But as this Politifact analysis shows, it is a misleading notion. Both countries impose import tariffs on each other's products already. Though it’s true that China does impose higher import tariffs than the U.S., it's a lot less asymmetric than Trump implies.

For example, using average rates for non-agricultural products, China levies a tariff of 5 percent on U.S.-made imports into their country, whereas the U.S. levies 2.9 percent on Chinese goods imported into America. China has higher tariffs for sure, but the difference is close to two percentage points, not a whole order of magnitude.

So, if all of a sudden the U.S. imposes a 35 percent tariff on all goods made in China -- or anywhere else for that matter -- America would be practically inviting a trade war. This is perhaps why Trump’s threat focuses on imports from U.S.-owned companies only, so as to avoid triggering international economic mayhem.

That being the case, what would be the effect of a 35 percent import tariff imposed only on goods imported from U.S.-owned companies?

By way of example, Apple iPhones would presumably be subject to a 35 percent tariff. But Samsung phones, made in China by a South Korea-based company, would suffer no such tariff. The result? People would have to pay higher prices for their iPhones, but not for their Samsung phones -- so fewer people would buy from Apple. This, to be sure, is no doubt the calculation behind the whole plan; a loss of sales would be the incentive for companies like Apple to bring jobs back to the U.S. But would they?

Likely not. The electronics industry has a highly Asia-centric supply chain that cannot be relocated in an instant. And even if that were to happen over time, doing so would not change the economic impact of lower wages in Asia versus the U.S.

Consequently, even if jobs eventually came to the U.S., the iPhone would still cost more when American wages are factored in. So, likely both in the short and the long term, Trump’s plan would reward foreign-owned companies over domestic ones.

Imagine the uproar from CEOs of American firms, who would quickly point out that the supposedly 'free' market is now instead skewed in favor of foreign firms. Such tampering of the market is about as far away from conservative ideals as you could possibly imagine from a Republican president, and it would help neither American companies nor American consumers.

So, to correct the uneven playing field, what might happen instead?

The administration could impose a 35 percent tax on all imports, as Newt Gingrich suggested over the weekend. Set aside for a moment the likely trade war, what would be the domestic implications of this?

Under these conditions, in our example, Apple and Samsung would compete on equal footing, at least from the tariff perspective. But assuming the tariff is passed along to consumers, now all smartphones are subject to 35 percent inflation. How long will it take before Americans feel ripped off when that happens?

Furthermore, when such price hikes are applied to all kinds of imported consumer goods, general inflation would result. And by chain reaction, that would induce higher interest rates, which would induce lower investment as the cost of money rises. And of course, as mentioned before, the country would invite the likelihood of trade wars.

So, in short: Inflation, high interest rates, reduced investment and a trade war would be a quadruple detrimental whammy. Even if over time jobs came back to the U.S., at the very least there would be short-to-medium term price shocks subsequent to a general import tariff of 35 percent. Americans would feel, and would be, worse off.

Back, then, to the scenario Trump has promised -- in which the tariff applies only to U.S.-owned companies’ imports. Another possible unintended consequence might be a quickening of corporate flight. We’ve already seen many companies acquire foreign competitors only to announce they will adopt the homeland of their newly acquired firm by effecting a “corporate inversion.”

Under this boondoggle, an American company -- by claiming to move its headquarters overseas -- effectively invokes denial of its American citizenship to avoid paying taxes. Companies do this already to sidestep America’s relatively high 35 percent rate of corporate tax (Europe’s is 24 percent), so it's easy to suppose inversions might gain popularity as a tool to avoid paying the punitive new import tariff.

The argument would be: We’re no longer a U.S. company, so we don't need to pay the import tariff. These inversions are egregious, of course, and the Obama administration has been urging Congress to regulate against them for some time; perhaps it would be a good thing if this actually moved the needle on this issue.

Another possible risk may also stem from a later point Trump tweeted out: “These companies are free to move between all 50 states, with no tax or tariff being charged.”

In essence, this is fair as it allows states to compete with one another. But it might also be a signal that states which dismantle rules on organized labor -- to drive down wages -- won’t raise eyebrows in the White house. What seems highly likely, in any case, is if jobs are forced back to the U.S., the downward wage pressure will be great as American companies try to compete globally.

So these are at least some of the risks, but the question is: Will Trump get his way?

Firstly, would he have any willing support from business leaders? On some level, the pain of the import tariff would be softened by Trump’s overall tax proposals. He wants to reduce the corporate tax rate to 15 percent, and would support a "tax holiday" to allow American firms to repatriate accumulated overseas profits at 10 percent. This would free up capital and would, to some degree, offset the cost of bringing some jobs back to the U.S. for some companies.

But industrial leaders are likely scratching their heads to fully understand what is really at stake. And since Trump’s tweets are not fully-fledged policy proposals, there are more questions than answers.

For example: Does Trump mean to slap the 35 percent tariff just on products currently made here that are subsequently moved offshore when he takes office? Or does he mean he would also apply the tariff on products already made overseas today? No details are available on this.

Also unclear is how the penalties would apply if a company “fires its employees” as his tweet promises. Does this mean the tariff applies when American workers are fired only when those specific jobs can be identified as moving overseas? Or does he mean the tax applies whenever a company lays off workers, period?

We would no doubt see the impact during the next recession when a company has to reduce its workforce to survive. Would a company already in financial distress be hit by a 35 percent tax on top of that, making its position still more precarious? Perhaps to maneuver around this clause, companies will fast-track their efforts toward automation to safeguard against a "firing tax." No workers to fire, no tax to pay. No American jobs either way!

A lot more thinking-through is needed. But in any case, while we wait for actual policy, Trump may be setting up for fight with his own party.

Republicans in Congress are keen to stymie his import tariff plan. On Monday, House Majority Leader Kevin McCarthy, the No. 2 Republican in the the House, said of Trump’s threat, “I don't want to get into some type of trade war." He went on to say he would not commit to bringing the tariff proposal to the House for a vote, adding: “I believe in the free market. I don't think government should be picking winners and losers.”

Speaker of the House Paul Ryan also indicated he has no intention of handing policy decisions to the president elect, previously saying about Trump’s tax plans: “Congress is the one that writes these laws and puts them on the president’s desk.”

But since we know Trump doesn't have too much time for protocol, could he force his ideas through by executive order in the face of opposition? Worryingly, it seems he possibly could. There is precedent for executive order on such matters, Andrea Seabrook, a commentator on NPR, said on the broadcaster’s Marketplace podcast on Monday.

One path available is to use the Trading With The Enemy Act of 1917, which allows for unlimited tariffs during times of war, Seabrook said. Apparently, former President Richard Nixon used this provision in 1971 based on the Korean War, which at the time was no longer being fought. It appears the law doesn't require the U.S. to be at war with the specific country in question, in order to impose tariffs. But if this doesn't fly, it’s not Trump’s only recourse.

He could use the International Emergency Economic Powers Act of 1972, which might be invoked on the basis that jobs leaving the U.S. constitute an economic emergency -- another means of handing the authority to impose tariffs to the executive branch.

So, beware of laws that were passed to provide loopholes and exceptions during times of emergency! Perhaps Trump will try to use them.

Then again, possibly he is merely using his early-morning tweets, as is often the case, to build emotional momentum behind a general idea as opposed to actually promising to do what he says. If the United States is to remain competitive in the international marketplace, and wants to avoid trade wars, we must at least hope it is the former.

Image credit: Flickr/Matt Johnson