While the Trump Administration’s radical trade policies are being enacted one after another, a new trade issue has emerged. In fact, the American political circles have been butting heads over the Border Adjustment Tax since last year. The Border Adjustment Tax is said to be the dark horse of American protectionism. We’ll learn more about what the tax law stipulates and what kinds of impacts are expected from its enactment with Park Dong-wook (박동욱), the head of the Market Research Department of the Korea Trade-Investment Promotion Agency. First, let’s find out more about the contentious Border Adjustment Tax.
The Border Adjustment Tax refers to a U.S. tax amendment bill under which exported goods are exempt from tax while imported goods sold domestically are subject to the tax. For example, let’s say an American company imports about $7,000 worth of parts to make and sell a product worth about $10,000. Under current tax laws, the standard for assessment is $3,000 when calculating the corporate tax rate. However, if the Border Adjustment Tax is introduced, the $7,000 would not be considered an expense, and the corporate tax rate would be assessed based on the whole $10,000. This means that the corporate tax burden will increase in multiple folds.
The Border Adjustment Tax amendment bill is designed to levy a tax on imported goods while exempting exported American goods. The Border Adjustment Tax was first devised in 2005 under the George W. Bush Administration. However, the bill was opposed by the Democratic Party, as well as by some Republican lawmakers, on the grounds that it violates the free trade principles. The idea seemed to have disappeared, but it has made a comeback recently. What led to its resurfacing?
During his campaigns, Donald Trump expressed his wishes to impose a customs levy on certain countries, such as China and Mexico. But in such a case, the countries in questions would not sit idly and tolerate such trade retaliation, and there is high probability that the move would lead to a global trade war. The Republican Party therefore suggested the Border Adjustment Tax as a means to alleviate the trade deficit problem with relatively smaller resistance from the major trade partners. In addition, the Border Adjustment Tax was designed with two effects in mind, namely import reduction and export promotion. The Trump administration is now drawing up tax laws with a plan to reduce the current U.S. trade deficit by 50 percent.
If the Border Adjustment Tax is enacted, American exporters will receive large tax benefits, while importers will be dealt a huge blow. This will inevitably lead to export promotion and import reduction, as desired by the Trump administration. Meanwhile, it will have negative impacts on Korea, which exports cellphones, home appliances and other consumer goods to the U.S.
Introduction of the Border Adjustment Tax would raise the prime prices of Korean imports in the American market. Korean products that have been benefiting from the revitalization of the American domestic market, such as cellphones, home appliances, daily goods and automobiles, are expected to be hit hard. Also, there are many Korean companies that export parts to the U.S., such as electronic components, semiconductors and petrochemicals. These firms may be hurt by the tax as well.
If the Border Adjustment Tax is enacted, the prices of foreign goods in the American market will rise. Prices of almost all consumer goods supplied to large shopping malls and department stores, including clothes, food and beverages, and home appliances, will be raised by over 20%. As a result, the price competitiveness of Korean consumer goods exported to the U.S. will drop. Prices of cars are expected to increase by about 8% from the current average price as well. The price hike will likely lead to a drop in sales by some 2 million units per year. Damages will be inevitable to Korean carmakers with a high export rate to the U.S. But this is not the only threat of the Border Adjustment Tax.
Countries with large export volumes to the U.S. will be hurt the most. In particular, China, whose exports to the U.S. reach about 460 billion dollars, is forecast to receive the biggest blow. Peterson Institute for International Economics projected China’s exports to the U.S. to decrease by about 46 billion dollars, or over 10% under the Border Adjustment Tax. According to a report by the Bank of Korea, intermediary goods account for 68.7% of Korea’s exports to China, 5% of which reach the U.S. in the end. If the U.S. introduces the Border Adjustment Tax under such circumstances, the BOK estimates Korea’s total exports will drop by 0.36%. That’s just the exports via China. We must also take into consideration the reduction of Korea’s direct exports to the U.S.
The Border Adjustment Tax influences indirect exports as well. Introduction of the tax law is expected to result in the reduction of China’s exports to the U.S. by more than 46 billion dollars per year. Meanwhile, Korea’s intermediary goods exports to China accounts for 68.7% of all of its sales to China. In other words, Korea exports intermediary goods to China who then manufactures finished products using the Korean intermediary goods to export in the global market. This means that a drop in China’s exports takes down Korea’s exports in tandem as well. The Border Adjustment Tax promises to be another piece of dark cloud over Korea’s exports, if enacted in reality. What should Korea do in the face of such a threat?
We must analyze in detail the potential impacts of the tax on Korea’s exports, industry, and finances, and monitor the results. If the tax actually becomes enacted, Korean companies should seek to diversify their advancements in the U.S. They should strengthen their presence in the U.S. and secure a base of production in order to get a step ahead of rival nations who have yet to make their way into the local market. Also, while the Border Adjustment Tax is easy to impose on commodity trade, it is not so as easy to apply to trades linked to services such as technology service, software or finances. So Korean firms should no longer simply export goods, instead they should aim to export high-value compound projects that involve multiple elements such as goods, services, design and technologies.
The United States’ trade partners including the European Union are warning that they would legally challenge the U.S. Border Adjustment Tax at the World Trade Organization, if the U.S. introduces it. Regardless, the wall of American protectionism is getting taller. Korea should devise multi-faceted countermeasures, including establishing local production systems and designing high-value exports, in order to make it over the wall that’s fast becoming a reality.