Tax Analysts Blog

Trump Only Threatens a Trade War, But Obama Might Actually Start a Tax War

Posted on Mar 22, 2016

The ever more likely and the ever less liked Republican presidential nominee, Donald Trump, has variously and vacuously threatened that on acceding to the Oval Office, he would slap tariffs of 35 percent on Mexican imports, including Ford cars and Carrier air conditioners, and 45 percent on all Chinese products brought into the country.

Virtually all of the mainstream media decried those declarations as rank hypocrisy, pointing out the Chinese origins of much of the clothing and many of the teddy bears on sale at the Trump Store in Trump Tower on New York's Fifth Avenue. Most media outlets also expressed alarm that Trump would unleash a global trade war, harming American consumers in the process. That professed concern for the domestic consumer is usually disproportionate and often disingenuous.

Consumer benefits is not the altar at which the economic orthodoxy of free trade worships. To the contrary, its ruling paradigm is efficient allocation of resources. And its frame of reference is global. That is why all free trade agreements allow for remedies, including tariffs, in cases where foreign sellers engage in dumping—exporting at below home market prices—or benefit from home government subsidies. In each instance, the artificially lower price would only benefit consumers in the importing country. But retaliation is permitted because that price would send the wrong market signals, resulting in a misallocation of resources not necessarily in the importing or exporting country but possibly in third countries.

Among the publications bewailing a Trumpian tariffs-led trade war are many left-leaning ones, not exactly great fans of free-market economics and trickle-down theories. After all, economic dogma doesn’t claim that free trade will have no winners or losers. Instead, it suggests that the gains of trade will become available to make the losers whole and then some. To be sure, the last quarter century of liberal trade policies has offered American consumers a greater range of more affordable imports. But perhaps even greater benefits have flowed to the U.S.-based multinationals that have moved production abroad. Those benefits, reflected in heftier bottom lines and loftier stock prices, have largely been captured by stockholders and executives lavished with stock-based compensation. Little, if any, has trickled down to displaced workers.

Moreover, the United States’ large trade deficits, and correspondingly large capital account surpluses, have resulted in large foreign investments in not just U.S. government securities but also U.S. equities. Thus, the very same liberal trade policies that have delivered enormous gains to U.S.-based multinationals have also helped diversify their ownership base across the globe. Many have also added extensive foreign managerial cadres to oversee their interests abroad. As a result, while the costs of free trade have largely been borne by the U.S. worker, the benefits have been spread across the world.

Little wonder then that in negotiating and implementing free trade deals, the U.S. government has come to be seen as representing the interests of these U.S.-based multinationals. That perception extends over to the arena of international taxation, and not without justification.

Even as the Chinese use their antitrust laws to favor homegrown businesses, the European Union is retroactively applying novel interpretations of its antitrust rules to scrutinize the transfer pricing practices of U.S.-based multinationals, such as Apple, Google, and Starbucks, that may have allowed them to minimize their European tax liabilities. The Obama administration has leapt to these businesses’ defense. In a strongly worded letter to the European Commission President Jean-Claude Juncker, U.S. Treasury Secretary Jack Lew accused the commission of unfairly targeting U.S. companies for retroactive tax increases, a charge that an EU spokesman rejected. Nonetheless, Lew’s Treasury Department is reported to be “closely” reviewing a never-used 82-year-old law as a means of retaliation. That law, IRC section 891, authorizes the U.S. president to double the rates of taxation otherwise applicable to citizens and corporations of a foreign country that he finds is subjecting U.S. citizens or corporations to discriminatory or extraterritorial taxes.

It is an open question whether the phrase “foreign country” in Section 891 could cover a supranational entity such as the European Union. In the context of credit for taxes paid to a foreign country, for example, the Supreme Court has held that the term “foreign country” is not limited to international states, but embraces any foreign government competent to lay the tax sought to be credited. If, on the advice of Treasury, Obama does invoke Section 891, the U.S. tax liabilities of all EU corporations and individuals could be increased by up to 80 percent. Trump’s 35 percent and 45 percent retaliatory tariffs seem modest by comparison.

In December 1993, a Democratic President, Bill Clinton, heralded the modern free trade era when he signed into law the North American Free Trade Agreement Implementation Act, legislation that spurred large-scale outsourcing by U.S.-based multinationals. Today, another Democratic administration is going to bat for some of these multinationals, seeking to help them retain more of their profits. In contrast, the leading Republican candidate for the presidency campaigns on the need for American businesses to retain their production within the country, and claims he can browbeat them into doing so by the mere threat of tariffs. Those waiting for a realignment of political forces in the country may finally be able to call off their watch soon.


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