Tax Analysts Blog

If Elected, Donald Trump Could Start a Trade War All by Himself

Posted on Jun 9, 2016

Donald Trump is a big fan of tariffs. He’s made them a cornerstone of his get-tough trade policy, suggesting (among other things) a 45 percent import duty on Chinese goods and a 35 percent tariff on cars manufactured in Mexico. And as Time magazine recently observed, he’s not the least bit concerned about the potential fallout. “Who the hell cares about a trade war?” he said last month.

For Trump, tariffs are a vital weapon in the global battle for economic advantage. When asked about his China levy, Trump explained his thinking. “The 45 percent tax is a threat,” he said.  “It was not a tax; it was a threat. It will be a tax if they don't behave.”

Political leaders have been using tariffs to coerce other countries for centuries, but they’ve used other taxes, too. Thanks to an obscure provision of the Internal Revenue Code, the U.S. president has the power to weaponize the individual and corporate income tax – without consulting Congress or anyone else.

Code section 891 grants the president sole authority to double tax rates on individuals and businesses from any country that discriminates against Americans using its own tax laws.

As my colleague Stuart Gibson recently pointed out, that arrangement is unusual. “Most U.S. tax laws are implemented under authority of the Treasury secretary ‘or his delegate,’” Gibson wrote.  “Section 891 is the rare exception, in that it expressly empowers the U.S. to double tax rates on the sole authority of the president."

The history of section 891 might be interesting to Trump, since it underscores the utility of using taxes to coerce trading partners. When first enacted in 1934, the provision wasn’t aimed at China, Mexico, or any of Trump’s other contemporary targets. Rather, it was directed at one of America’s most reliable if sometimes prickly allies: France.

And it forced the French to back down.

In December 1933 American newspapers reported the apparent start of a trade war. "Huge French Levy Laid on Americans," blared a New York Times headline.  "$122,650,000 Is Assessed on Firms by Double Taxation Despite Pact to End It."

The dispute had been brewing since 1926, when France first tried to apply a 50-year-old tax law to American companies. The measure required every company or subsidiary of a company doing business in France to pay normal income taxes, just like all French companies. In addition, however, they had to pay taxes on the profits earned by the parent company and all its subsidiaries around the world. As The New York Times explained at the time, the provision was meant to discourage profit shifting by French subsidiaries of foreign companies.

When French authorities began enforcing the law, they reached back to its origins when assessing taxes due. The result was a truly mammoth tax bill, at least for some companies. "The French have never collected anything on it, so if the companies have to pay it will represent a staggering amount in many cases," one newspaper reported.

The assessments were not new in December 1933, but their public disclosure was. And the revelation came while American and French authorities were engaged in a broader negotiation over bilateral trade policy. In fact, the disclosure had been orchestrated by "an irate importer" from the United States who objected to French policy on other trade issues, notably wine quotas.

French and American officials had been trying to resolve the issue for years, and a bilateral agreement, signed by both nations in 1932, seemed to get the job done. But while the U.S. Senate had promptly ratified the treaty, French lawmakers had not.

U.S. officials had no way to force the French to act. "There was no basis in our law for prevailing upon the French government to forgo this form of double taxation," one American official later recalled.

So Congress decided to create one.

Rep. Fred Vinson, D-Ky.,  proposed the adoption of "reprisal taxes" for nations that discriminated against American taxpayers. "There are nations throughout this world who are not particularly friendly to Uncle Sam in a business way," Vinson told his colleagues. "And when they get the opportunity to dig into the pocketbook of his citizens, whether individual or corporate, they have not hesitated to do so."

Vinson suggested that a reprisal tax would serve as a deterrent against future discrimination, as well as a remedy for existing inequities. "This power can be used to protect American business from present discrimination and will probably help restrain foreign countries from further discriminatory levies," he said.

As eventually passed, the Revenue Act of 1934 gave the president authority to double taxes on companies and individuals from any country that discriminated against Americans.

But not all Americans liked the idea. "Resort to tax reprisals as a means of securing redress for grievances real or fancied, is likely to fortify foreign governments in their determination to discriminate against American concerns," complained The Washington Post. And initially, the Post seemed to be right; two months after passage of the reprisal taxes, French lawmakers adjourned for their summer break without taking action on the pending treaty.

The U.S. did not respond by invoking its new reprisal taxes. But the lingering threat seemed to have the desired effect on French officials. In December 1934 the French Parliament moved to ratify the treaty, abolishing double taxation and ending the incipient trade war.

What does the early history of section 891 tell us? Maybe that threats work.

But that’s not really the issue. The important question today, as in 1934, is whether threats are worth the risk. In 1934 things turned out well for the United States. And they might again, should a President Trump try to use section 891 – or any other sort of reprisal tax – against our trading partners.

But threats are not without risk. Trump may not care about a trade war, but lots of other Americans probably do.

This item is drawn from a larger article originally published in Tax Notes magazine and available through the Tax History Project at Tax Analysts.

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