Posted on Mar 8, 2017

Many people are talking about a border tax these days, but how many know what proposals from the White House and Congress really mean?The highly debated proposal from President Donald Trump would impose a tariff, or border tax, on manufactured goods imports from certain countries, most notably China and Mexico. Republicans in Congress agree that action is needed, but have proposed an alternative border adjustment tax. With the news coming out of Washington D.C. confusing at times, there are several critical questions relating to both plans. This Q&A attempts to clear up some of the issues.

Q. How would the proposed Trump plan work?

A. The aim of the tariff, or border tax, is to discourage U.S. companies from importing goods from certain firms outside the United States, particularly some that have set up shop in Mexico and elsewhere to produce goods for the U.S. market. Although details have remained vague, Trump has said that the tariff would be “very major” and could be as high as 35%, a figure he once proposed should apply to automobiles made by U.S. companies in Mexico. The tariff would be accompanied by Trump’s proposed across-the-board reduction in corporate tax rates to 15%.

This plan, however, would likely violate the North American Free Trade Agreement (NAFTA). But Trump has long advocated changing that pact and other trade agreements and has threatened to pull out of NAFTA.

Q. What about the Republican plan?

A. Leading Republicans in the House of Representatives — notably Speaker Paul Ryan (Rep.-WI) — would include a border adjustment tax as part an overhaul of the corporate tax system. Along with reducing corporate income taxes to 20%, that plan would shift taxation to a territorial-based system in which companies are taxed where income is earned. The cost of imported parts or goods for use or sale in the United States would no longer be tax-deductible, while income from exports would be excluded from tax. This approach is designed to bring manufacturing and other firms back into the country.

Initially, Trump characterized this tax plan as being “too complicated,” but later signaled a willingness to work with the House leadership. If this approach is implemented, companies would have to factor in the higher cost of imports, minus any deduction.

However, the plan may violate World Trade Organization (WTO) rules. The WTO permits border adjustments for indirect levies (such as value added taxes), but a direct tax on income may be banned.

Q. What is the history of imposing tariffs?

A. Prior to the introduction of the federal income tax in 1913, tariffs were the main source of revenue for the U.S. government. They reached a high in 1930 when tariff legislation was passed to protect workers during the Great Depression. After other countries responded with their own high tariffs, the United States gradually cut back. These reductions were subsequently enhanced by WTO efforts to lower tariffs.

Currently, U.S. tariffs are assessed on a wide number of goods, ranging from automobiles to running shoes. Non-agricultural products, which account for the vast majority of goods imported into the United States, have an average import tariff of 2%. About half of all industrial goods entering the country are exempt from tariffs. Since 1994, NAFTA has gradually eliminated U.S. tariffs applying to Canada and Mexico.

Q. What is expected to happen if the Trump tariff is imposed?

A. For starters, by raising costs for U.S. importers, the proposed Trump tariff would encourage companies to increase domestic production, while eliminating some of the benefits of manufacturing in countries with lower wages. The Trump administration expects that the tariff would help restore manufacturing jobs as domestic production climbs.

But critics assert that the border tax would also likely result in higher prices for U.S. consumers, especially if other countries react negatively, as many expect them to do (see Is This a Declaration of War? below). Ultimately, a trade war could produce shock waves around the world and could even conceivably lead to a recession or, worse, a depression.

Q. Does President Trump have the authority to impose his tariff plan?

A. Some of Trump’s actions since he took office have raised constitutional issues that haven’t yet been resolved. But it appears that he would be standing on relatively firm ground with tariff-related actions. Congress has the constitutional power to regulate commerce with foreign countries, but that power has often been delegated to the president.

For example, under the Trade Act of 1974, Trump may be able to impose tariffs on countries that violate trade agreements or engage in unfair trade practices. That law effectively allows the president to levy temporary surcharges of up to 15% for as long as 150 days. (Back in 2009, former President Obama relied on this provision to apply a tariff on tire imports from China.) Alternatively, Trump might rely on emergency powers that would allow him to restrict imports in the name of national security.

Q. Could Congress override Trump’s tariff plan?

A. Yes, but it takes a two-thirds majority in both houses of Congress to override a presidential veto. Based on the current makeup of both chambers and the general support that Republicans have shown the new president thus far, this scenario would appear to be unlikely.

Furthermore, if any actions are found to violate NAFTA or the WTO, President Trump has the potential option of simply bowing out of those agreements. In other words, if a tariff plan is implemented, it is likely to stand up to scrutiny.

Is the United States Declaring War?

Don’t expect other countries to take a new U.S. tariff plan lying down.

Foreign nations could initiate legal actions in U.S. courts or through the WTO. What’s more, countries like China or Mexico could respond with their own tariffs on specific companies and goods. Of course, some nations already have tariffs in place, such as the Chinese levy on imported automobiles.

There’s no way of knowing what the full impact of a global trade war would be. But most economists believe there would be more losers than winners once the dust settles.